Students often overlook federal loans that are great deals

ByABC News
October 30, 2007, 2:22 AM

— -- In the Land of Oz, there are good witches and bad witches. Likewise, in the land of borrowing, there's good debt and bad debt. A home mortgage? Good debt, because the interest is tax-deductible, your home will likely rise in value over time, and you'll have a roof over your head. A credit card loan to buy a pair of designer sandals? Bad debt, because credit card interest isn't deductible, your purchase will decline in value and you can't live in your shoes.

Student loans are often categorized as good debt, because a college education is considered a sensible long-term investment. In 2005, the typical full-time worker with a four-year college degree earned 62% more than an employee with only a high school diploma, according to the College Board. And many students can't afford to attend college without borrowing money.

But it's important to understand that not all student loans are alike. Federally guaranteed student loans, known as Stafford loans, have fixed interest rates, now 6.8%, and flexible repayment terms. Any full-time college student, regardless of family income, can take out a Stafford loan.

Private student loans, which are often offered by the same lenders that provide federal loans, are more expensive. Interest rates are variable, so there's no limit on how high they can go. And repayment terms aren't as flexible as they are for federal loans.

Yet despite these drawbacks, private student loan borrowing has soared in the past decade. This year, private loans accounted for 29% of all loans taken out by undergraduates, according to a report released last week by the College Board.

The amount of federal money that students can borrow is limited, and those limits haven't kept up with increases in college costs. As a result, some students who attend high-cost schools rely on private loans to pay for expenses not covered by their federal loans.

But that doesn't entirely explain the growth in private loans. An analysis by the American Council on Education found that one in five undergraduates with private loans didn't first take full advantage of federal loans.