College is expensive, and it’s not getting any cheaper. This is why it pays to know the best student loan options.
The average cost of tuition and fees at public universities increased another 4% in the past year, and costs went up at private colleges by 3%. Tuition and fees at ranked U.S. schools now average $10,116 to $36,801 per year, and that excludes additional costs such as housing, food and books.
Fortunately, you can find ways to pay for college and save money in the process by understanding the different types of student loans and which ones are right for your situation.
In this article, we’ll take a look at the six types of student loans. We’ll start with the two best options and then review four additional options if you still need more money (which many people do):
- Subsidized Direct Loans
- Unsubsidized Direct Loans
- Parent PLUS Loans
- Private Loans
- Home Equity and Mortgage Loans
- Retirement Plan Loans
We’ll show you how these loans work, explore the pros and cons of each option, and provide advice to help you determine which type of student loan is the best for you.
All of this is based on official loan program details, terms, and numbers. And it’s backed by more than 20 years that I’ve spent helping families plan and save for college as a Certified Financial Planner® and college funding advisor.
Let’s get started and explore your best student loan options.
Starting with the Two Best Options: Direct Loans
Direct Loans are generally the best student loans because of their favorable interest rates, terms and flexibility. These loans are made in the student’s name, there is no credit check, and parents are not part of the process.
In total, between Subsidized Direct Loans and Unsubsidized Direct Loans, you can borrow up to $27,000 over four years of college, with annual limits based on your year in school.
Here’s a quick look at the total Direct Loan borrowing limits as of 2019-20:
Direct Loan Borrowing Limits
(for Dependent Students)
|College Year||Total Borrowing Limit|
1. Subsidized Direct Loans
The best option between the two types of Direct Loans is the Subsidized Direct Loan.
However, Subsidized Direct Loans are only available to students who qualify based on financial need. To qualify, you must demonstrate a financial need based on the information you report in your annual FAFSA (Free Application for Federal Student Aid).
Don’t worry if you don’t qualify, though. You can still borrow money through Unsubsidized Direct Loans.
With Subsidized Loans, qualifying students can borrow up to $19,000 over four years of college. Additionally, they have the option to borrow up to $8,000 in an unsubsidized loans, bringing the overall Direct Loan borrowing limit to $27,000.
Subsidized Direct Loan Borrowing Limits
(for Dependent Students)
|College Year||Subsidized Borrowing Limit||Optional Unsubsidized Amount|
With a Subsidized Direct Loan, the U.S. government subsidizes the loan by paying your interest while you’re enrolled in college. And you don’t have to start making payments until six months after graduation.
Once you graduate and start making payments, interest will be applied to your balance, and you’ll be responsible for making monthly payments.
Now that you understand the basics, let’s review the pros and cons of Subsidized Direct Student Loans and whether they’re a good option to consider.
- Subsidized: the U.S. government pays your interest while you’re enrolled for four years
- No payments due during your four-year enrollment
- No payments due until 6 months after graduation
- Interest rates are often significantly better than other types of loans.
- There are relatively low borrowing limits, so Direct Loans may not cover all your college costs.
- Interest will be applied and will accrue after you graduate
- Subsidized Direct Loans are a no-brainer if you qualify and you need to borrow money.
- They’re almost always the best overall student loan option.
2. Unsubsidized Direct Loans
Unsubsidized Direct Loans are the other type of Direct Student Loan available from the U.S. Department of Education. These loans are available to all students, even if you don’t show a financial need.
With an Unsubsidized Direct Loan, you can borrow up to the maximum of $27,000 in Direct Loans over four years of college, within the annual limits for your year in college.
Unfortunately, since the government doesn’t subsidize these loans, interest accrues while you’re enrolled in college, and you’re responsible for paying that interest, plus any interest that accrues after you graduate and you start making payments. This makes them slightly more expensive than Subsidized Direct Loans, but they’re still a great option.
However, you don’t have to start making payments until six months after you graduate. These loans are also made in the student’s name, so parents aren’t involved or responsible for repayment. And there’s no credit check required.
Again, this assumes you qualify for Subsidized Loans based on financial need, but here’s a breakdown of the total amounts you can borrow through the Direct Loan program:
Let’s review the pros and cons of Unsubsidized Direct Loans and whether they’re a good student loan option.
- You can borrow up to $27,000 over 4 years of college (any Subsidized Direct Loans you take out will reduce this amount)
- All students qualify for Unsubsidized Direct Loans, regardless of financial need.
- No payments are due during your four-year enrollment
- Your first payment isn’t due until 6 months after graduation
- There are relatively low borrowing limits, so Direct Loans may not cover all your college costs.
- Interest accrues while you’re enrolled in college and after graduation
- Interest rates are not as good as Subsidized Direct Loans
- Unsubsidized Direct Loans are often a good option if you don’t qualify for Subsidized Direct Loans or still need additional money for college.
- Make sure to compare Unsubsidized Direct Loan interest rates against the rates you might receive from private student loans (see below).
- If you or your family has excellent credit, you may qualify for better rates from a private loan than an Unsubsidized Direct Loan.
The Four Additional Loan Options
If you aren’t able to cover your college costs with subsidized or unsubsidized loans and you still need more money, there are four other loan options to consider.
3. Parent PLUS Loans
Parent PLUS Loans are offered to parents by the U.S. Department of Education, through schools that participate in the federal Direct Loan program. With a PLUS Loan, parents borrow money in their name, and they’re responsible for paying it back. The student isn’t involved.
Parents can borrow up to the total cost of attendance at a particular college, minus other financial aid received. That means a PLUS Loan can help you cover the costs that Direct Loans and other financial aid don’t cover.
You can request a deferment to delay payments until six months after graduation, but interest accrues while your student is enrolled at least half-time.
PLUS Loans aren’t based on financial need, so parents can qualify by simply having decent or marginal credit. If you have poor credit, you might still qualify if you meet additional requirements. Most parents do.
Parent PLUS Loan interest rates are always 2.55% higher than the rates for student Direct Loans. It’s a difference fixed by law.
Currently, for the 2019-20 school year, the parent PLUS Loan rate is 7.08%, which is down from the previous year. Rates are updated each year, so always make sure to check the current rates for the upcoming school year when evaluating a PLUS Loan.
It’s also a good idea for parents to explore other loan alternatives, since families with home equity or really strong credit may be able to borrow at a better rate.
Let’s review what we’ve learned about Parent PLUS Loans and their pros and cons:
- Parent PLUS Loans are available for most parents, even if you don’t have strong credit.
- Parents can borrow up to the total cost of attendance, minus other financial aid.
- If you request a deferment, no payments are due while your student is enrolled.
- You can also request a payment deferment until 6 months after graduation.
- Parents must borrow the money in their name, and they’re responsible for paying it back.
- Interest accrues throughout the life of the loan, including while your student is enrolled.
- Parent PLUS Loan interest rates are always 2.55% higher than Direct Loan rates.
- Parent PLUS Loans are a good option if other financial aid doesn’t cover your college costs and you need more money.
- If parents have home equity or excellent credit, they may qualify for a better rate from a private loan.
- Make sure to compare your Parent PLUS Loan interest rate against the rate you might receive from private loans.
4. Private Student Loans
Private student loans are loans where students and/or parents borrow from a private bank or other financial institution to pay for college costs. Parents usually co-sign these loans and the loans are borrowed under the student’s name, but the loan is fully underwritten based on parents’ credit and their ability to repay.
Private student loans have terms and conditions that vary based on the lender and contract. These terms can vary from decent to awful, so buyer beware.
If you have good credit, you might qualify for a better interest rate than you might get from a Parent PLUS Loan. If you have poor credit, your interest rate will be higher, which means a Parent PLUS Loan might be a better option.
With a private loan, you may also have the option to make your student the primary borrower while you co-sign on the loan. This might be preferable to accepting sole responsibility for the loan, as parents must do with a Parent PLUS Loan. But you often have to pay a higher interest rate for the privilege.
Here’s a quick breakdown of the pros, cons and final verdict for private student loans:
- Private loans can provide additional funds when Direct Loans don’t cover enough of your college costs.
- If you have good credit, you may qualify for a good interest rate and a better one than you’d get from a Parent PLUS Loan.
- Private loans also allow a student to be the primary borrower while parents merely co-sign.
- If you co-sign on a private loan and make your student the primary borrower, there is usually an additional cost associated with this.
- Even if you co-sign on a private loan, you’re still ultimately responsible for repayment if your student fails to repay the loan.
- If you have poor credit, you might not qualify for a good private loan interest rate.
- Consider a private student loan if financial aid doesn’t cover enough of your college costs and you need more money, or if you don’t want to assume sole responsibility for a loan and want to co-sign for your student.
- Compare private student loan rates with your rate for a Parent PLUS Loan. If you have good credit, a private loan may be cheaper.
5. Home Equity/Mortgage Loans
If you own a home and have equity, a home equity loan or mortgage refinance could provide additional funds for college at a lower interest rate than you might get from a Parent PLUS Loan or other private loans. It depends on your credit, and if you have a good borrowing history, you might get excellent rates. Otherwise, a parent PLUS Loan might be your lowest cost option outside of Direct Loans.
However, when you borrow against your home equity, you’re putting your home at risk in the event that you’re unable to repay.
- Home equity loans or mortgage refinancing can help you access additional funds. For college.
- If you have good credit, you can potentially save money on interest compared to a Parent PLUS Loan.
- You risk losing your home if you’re unable to pay off the loan or refinanced mortgage.
- If you have poor credit, your interest rate may be high, so a Parent PLUS Loan may be a better option.
Consider a home equity or mortgage refinance if:
- Direct Loans don’t cover enough of your college costs
- You have good credit that qualifies you for a better interest rate than you’d get from a Parent PLUS Loan.
- You’re willing to take the risk of borrowing additional money against your home.
6. Retirement Plan Loans
Many retirement plans will allow you to borrow up to $50,000 for virtually any reason, which means you can potentially tap into your retirement to help pay for college.
Borrowing is typically limited to 50% of your retirement account balance, up to $50,000. That means you need $100,000 in your account to borrow the maximum amount. If you have less, you’ll have to borrow less.
The downside is that you lose the potential investment growth of that money, and you have to repay the loan. Typically it’s only a 5-year repayment window, so it often doesn’t work well for four years of college.
Sometimes the interest you pay—instead of going to your own account—goes to your plan provider, so you end up paying interest on your own money to someone else.
When it comes to using a retirement plan loan to help pay for college, I have some clear advice: DON’T DO IT! It’s a bad idea unless it’s part of a bigger plan.
For example, I’ve had families put an extra $30,000 into their retirement plan over two years of investing, so they can borrow a portion of that later. Doing this improved their ability get college tax breaks, which lowered their total cost of college.
If you’re a business owner, there are additional opportunities to be creative because you’re in control of your business’ retirement plan. Consult your financial advisor to learn more about your options.
However, unless you’ve planned ahead and added extra money to your retirement account to borrow for college, don’t take out a retirement plan loan.
Here’s the final rundown of the pros, cons and verdict on retirement plan loans:
- A retirement plan loan may allow you to borrow up to $50,000 to use toward college costs.
- Borrowing is typically limited to 50% of your account balance.
- You will lose the potential investment growth of any money you borrow.
- Typically there’s only a 5-year repayment window, which doesn’t work well for college.
- Don’t take out a retirement loan unless you’ve already put additional money into your account in previous years, with the explicit intent of borrowing it for college.
Determining Your Next Steps
Hopefully this overview has helped you figure out your best student loan options if you need to find money to pay for college. But student loans are just one part of a complete college funding plan.
Make sure your plan includes all the key elements that will help you save and pay for college and maximize your savings while minimizing your costs. To learn more, subscribe to my free e-newsletter and check out some of my other useful articles and resources.