2.25%(var) private loan VS Unsub Stafford Loan (6.8% Fixed)?

Lenders are pushing an unusual new product: a student loan that borrowers start paying off while they still are in school. Companies say customers can save thousands of dollars in interest over the life of the loan, but some experts are skeptical.

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The Daily Camera/Associated Press
Graduating students celebrate at the University of Colorado in Boulder last month.

These "immediate repayment" products—in which borrowers agree to pay back a certain amount of interest, and, in some cases, principal, each month once they take out the loan—have been growing more popular, says Shelly Repp, president of the National Council of Higher Education Loan Programs, a trade association representing private loan companies.

Sallie Mae, the largest private lender, now offers a Smart Option program with three repayment options: make the full interest payment each month while in school, pay $25 of interest monthly while in school or defer all payments until six months after graduation.

The lender says that 63% of borrowers originating loans in the 2011-12 academic year chose one of the two in-school repayment options. That is up from the 5% who made voluntary in-school payments in 2008, the year before the Smart Option loans were formally introduced.

SunTrust Bank and RBS Citizens Financial Group now offer similar loan programs, and Discover Financial DFS +0.48% says it is considering adding one.

RBS Citizens says originations of its TruFit student loans were up about 50% in 2011, though the percentage of borrowers choosing in-school payment held steady. SunTrust says more borrowers are choosing in-school repayment, but declined to provide details.

The push comes as the industry has taken criticism for making it too easy for borrowers to take on onerous amounts of student debt, which typically can't be discharged in bankruptcy.

The pitch: Borrowers can lower the amount of accrued interest and pay less in the long run. In addition, the lender typically offers a lower interest rate and might shorten the payment term.

Parents of college students are likely to be marketed these loans in coming weeks as they try to cobble together this year's tuition payments. But even the lenders say their products should be used only as a last resort after savings, financial aid and federal loans are used up.

Here's how they work: If a freshman borrowed $10,000 at an 8% annual rate, had a repayment term of 10 years after graduation and chose Sallie Mae's full-interest repayment option, he would pay about $67 a month while in school and around $17,960 total, according to estimates from Mark Kantrowitz, publisher of FinAid.org.

With the $25-a-month option, he would pay about $19,500 over the same period. If he waited until after college to begin repayment, he would shell out $20,430.

Sallie Mae typically puts those who choose an in-school option into a shorter repayment term than those who defer. That can further cut down on interest costs.

You can choose between a fixed or variable interest rate. Sallie Mae was recently offering a variable-rate loan at a minimum rate of 2.3% and a maximum 9.4%, and a fixed-rate loan between 5.8% and 11.9%. SunTrust was recently offering a minimum rate of 3.8% on a fixed-rate loan.

Derek Hernandez, a 22-year-old undergraduate at Florida International University, chose a $7,000 full-interest Smart Option loan for the just-finished academic year. He pays about $40 a month, which will save him around $2,800 compared with deferring payments, which would have made Sallie Mae put him in a longer repayment term.

When he graduates, Mr. Hernandez says, "I'm not going to be in such a financial hole. It's also building up my credit."

But these loans aren't necessarily the deal they are made out to be, says Robert Weinerman, senior director of college finance at College Coach, a firm in Watertown, Mass., and a former financial-aid officer at the Massachusetts Institute of Technology.

If you have extra cash on hand to make payments, you could do better by borrowing less and putting that money toward paying college costs directly, he says.

On the other hand, if you find yourself short on cash and unable to make the monthly payment while in school, you will find it hard to defer payments and will be considered delinquent, according to Sallie Mae.

And, if you continue to take out these loans each year, your monthly payment will rise, Mr. Weinerman says.

A $50 monthly payment freshman year would become a $200 payment senior year, assuming rates, loan amounts and repayment options stay the same. Because of this, the loans might be dangerous for students who can't fall back on their parents to make monthly payments.

Says Justin Draeger, president of the National Association of Student Financial Aid Administrators, "The jury is still out on these types of loans."

Hey guys,
I just got approved for LIBOR + 2% loan (= 2.25%) from Sallie Mae. I'm wondering if it makes sense to turn down the Stafford Loans for this, as the interest rate is just so low. I realize the risk is it could go up at any time, but since the repayment terms on both loans are only 10 years, it's a safe bet that over the course of the 10 years, the private loan will still be cheaper for me even at some point it does happen to get up above 6.8%.