An insider's guide to student loans

By Liz Pulliam Weston

There are two essential things you need to know about student loans:

• Lenders will give you every dime you need to pay for just about any education you desire.

• Just because you can borrow doesn't mean you should.

It's not that student loans are bad. Two out of five undergraduates need some kind of loan to get through school, and a reasonable amount of debt can be a good investment in your future.

Lenders, however, will give you far more money than you can comfortably repay. That's true even with recent improvements to federal student loan programs, which cut rates and installed income-based repayment plans.

Also, you should realize that once you take out student loans, the debt can follow you for life. Student-loan debt typically can't be erased in bankruptcy court, and there are no statutes of limitation that limit how long private lenders can pursue you for collection.

So it's up to you to set limits on how much you'll borrow and search for the best possible deals.

How much should you borrow?

If you're a student, you should generally limit your debt so that your loan payments after you graduate don't eat up more than 10% of your expected monthly income. Figure you'll pay $10 to $12 per month for every $1,000 you borrow if you repay the loan over a 10-year period.

If the math makes your head hurt, you can just use the rule of thumb that you shouldn't borrow more in total for your education than you expect to make your first year out of school.

If you're a parent, try to keep all your loan payments -- for mortgages, cars, credit cards and education -- to 35% or less of your gross monthly income. If you try to borrow more than 40% under some private loan programs, your application will be turned down.

Federal vs. private loans

Student loans come in two basic flavors: those that are provided or sponsored by the federal government and those that are not. Federal loans have better rates and terms than private education loans, plus they're more flexible -- offering more repayment options and even the chance to have some of your debt erased if your income is low.

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For example, as of July 2009, graduates will have the option to limit payments on federal loans to no more than 15% of their discretionary income or 15% of the amount of their income that exceeds 150% of the federal poverty level. (For example, the 2007 poverty level for a single person is $10,210, so payments would be capped at 15% of his or her income over $15,315.) Unpaid interest and principal is added on to the loan, but any balance would be forgiven after 25 years of payments.

Private loans, by contrast, typically can't be erased or forgiven and come with variable interest rates that start around 8% and can go as high as 19%.

Continued: 2 types of federal loans

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