Perkins Loans vs Stafford Loans

It’s a busy day around here, so I’m picking a short question today because it has a short answer. Nina wants to know what I think of paying off student loans with other student loans. Not a common question, but not unprecedented, either.

I’m a senior in college and I have completely reached my limit in Stanford loans, ( I really need them after losing my state scholarship freshman year.)

Check to be sure you’ve actually reached the limit — it’s $31,000 if you’re a dependent student and $57,500 if you’re an independent. If you really are maxed out, then let’s move on. And, I’m sorry. 🙂

Anyway, I’m trying to pay them off before I rack up more debt for Grad School in a year.

Impossible, unless you’re hoarding a suitcase full of cash somewhere in the Caymans. If you were in the position where you could pay off $31,000 in one year, then I don’t think you’d need to take out loans for your senior year.

Anyhow, even if you did have that kind of cash lying around, I don’t know that I’d advocate you paying it off anyway. You’ve got a minimum of 10 years to repay those Stafford loans, and you can easily stretch it out into 20 or 30 if you need to (not as easily done with Perkins Loans). Now’s probably the time where you need that money to live since you don’t have a well-paying job, so keep it.

Recently, I was eligible for the Perkins Loan for this year since I’m ineligible for the Stanford Loan. I wanted to know if I should use part of my Perkins Loan money to pay off some of Stanford Loan, because the Perkins Loan has more forgiving loan cancellations (like paying off some of the loan if you are teacher for x- amount of years). Please help I’m at crossroads!!

Sure. It’s a good question, actually, because the Perkins Loan is better than a Stafford Loan — USUALLY. The Perkins interest rate is fixed at 5%, which is great; HOWEVER, for the next two years, the subsidized Stafford rate actually dips well below the Perkins rate. It’s currently 5.6%, but next year (2010-11) it drops to 4.5%, and the following year it drops again to 3.4%.

After that, it shoots back up to 6.8% in 2012-13. So get your Stafford while the getting is good, people.

Now Nina, your Stafford limits will rise dramatically when you enter grad school, so it’ll be an option for you once again soon. But let’s address the question of whether, generically speaking, it makes sense to pay off one loan with another loan.

Speaking strictly in financial terms, it’s at least worth considering to do so if one loan comes at a lower rate than another. Smart people do this with credit cards all the time. If I owe $5,000 on one credit card that’s charging me 15% interest and another credit card will transfer that balance and carry it at 7%, then yes, that makes sense.

But don’t forget that student loans, compared to all other types of loans, have extremely lax repayment terms already. The rates are low, you can extend your repayment period over 20 or 30 years if you want to, and you can often even get a one-year forbearance just by picking up the phone and asking for one.

The moral of the story is: of all the loans you need to start busting your hump to pay back, this is not the one. Pay this one off last (zero interest loans excluded, of course).

But even beyond whether the long-term financial math makes sense or not, I wouldn’t tell you to pay off the Stafford with the Perkins even if the Stafford interest rate was higher. Why not? Well, you’re young and you’re in college and you’re trying to build your career.

There are better ways to spend that money that will get you a better return on investment (ROI) than by eliminating the additional interest you’ll pay on your other loans over 10 years. I’d much rather see you take it and use it for living expenses on a good internship, or to attend a couple of conferences and build a strong network of professional contacts.

Those contacts can make the difference between a decent job and a great job, or between finding a job in three weeks vs. finding one in 9 months. Don’t discount the financial disparity between those situations. In 9 months of unemployment, you’ll burn away in living expenses what you saved yourself in interest payments by doing an early payoff. And you burned it in 9 months.

Trust me, the government can wait for their money. The only scenario in which I’d advise you to pay off one loan with another is if you’re a hopelessly bad money manager who is absolutely destined to go waste the loan money on expensive clothes, vacations, hookers, methamphetamines, or other ill-advised purchases.

Otherwise, just keep the money and pay it back on schedule.

— That’s all I’ve got today. How about you — any thoughts on what Nina should do? Let us know in the comments below.