Our old friend Sallie Mae is up to her old tricks again: trying to sell students on extremely dangerous variable rate private student loans with this press release, which touts “changes in the law and improvements in the economy that translate into student loans at among the best interest rates in the last five-year period.”
The changes in the law, and resulting lower rates on some subsidized federal loans, happens to be true. But here’s where Sallie Mae jumps the shark into dangerous advice:
For college students who need private loans to fill the financial gap, Sallie Mae’s Smart Option Student Loan also offers new, lower variable rates and no disbursement fees. For the upcoming academic year, rates range between 2.25 percent APR and 9.37 percent APR for degree-seeking students, based on today’s LIBOR index. Sallie Mae also offers students in-school payment choices and shorter repayment terms that help lower the amount of interest paid over the life of the loan, as well as a new tuition insurance benefit. A typical freshman who borrows $10,000 and opts to pay interest while in school can save more than $5,200 over the life of the loan compared to a conventional, payment-deferred, private loan.
There are a bunch of issues with this paragraph, so let’s tackle them in order:
1. The rates start as low as 2.25% because interest rates are extremely low right now. But these are variable rate loans which means that, when interest rates are significantly higher in a few years, borrowers’ monthly payments will skyrocket.
2. The fact that interest rates are at historic lows makes this a horrible time to take out variable rate debt. There are two schools of thought on variable rate debt. The conservative one that I subscribe to is this: Borrowing money when you don’t know what the payments will be in a few months (or years) is just too risky, and you’re better off just avoiding variable rate debt altogether. The second school of thought is that people should take out adjustable rate loans when interest rates are at historic highs — that way the rate will float down as the LIBOR (or prime rate, or whatever) falls. There is no (responsible) school of thought saying that historically low interest rates make it a good time to take out variable rate debt — Sallie Mae knows better and is just being sleazy to suggest it.
3. Sallie Mae also touts savings of $5,200 over the life of the loan by making payments during college. Here’s the thing: you can save interest on any loan by making payments on it. The longer you wait to make payments, or the smaller the payments you make, the more interest you’ll pay. This is why we tell people not to make just the minimum payments on their credit cards. What Sallie Mae is doing here is the equivalent of selling a 500 calorie candy bar– with a big ad on the front that you can cut the calories in half by not eating half the candy bar. Yes: Sallie Mae does offer a small interest rate reduction if you make payments on it while you’re in school, but most of the savings from making payments while you’re in school can be had with any loan.
Here’s what students really need to hear about private student loans: Never use them.