Read the Fine Print on Alternative Loans: It Could Save You $1,500!

While recently shopping for alternative loans for my nephew who begins school this fall, I had the opportunity to review promissory notes from several different lenders.  According to Wikipedia, a promissory note "is a contract detailing the terms of a promise by one party (the maker) to pay a sum of money to the other (the payee). The obligation may arise from the repayment of a loan or from another form of debt."

Yes, I know, these documents can run into the dozens of pages or are written in such small fonts that you might need a magnifying glass to read it.  However, buried within this document are the key elements of your student loan, including the amount to be repaid, the interest rate, fees and repayment terms. 

PLEASE, PLEASE, PLEASE read the section in the Promissory Note that pertains to Interest Capitalization (it may also be described as how interest will accrue during the loan term) as it can save you $$$.  This section refers to how interest accumulates on your loan while you are in school, should you choose not to make payments (defer payments) until you graduate or leave your academic program.   

There are generally two ways in which lenders will treat the interest which accrues during this period:

• Interest that accrues during this deferral period (while the borrower is in school and not paying down the loan) is added to principal balance ONCE at the end of the deferment period (typically 6 months after you graduate or leave school).  THIS IS THE PREFERABLE OPTION.

• If accrued interest is not paid during the deferral period (while the borrower is in school and not paying down the loan), accrued interest is added to the Principal at the end of each calendar quarter.  AVOID LOANS WITH THESE TERMS IF AT ALL POSSIBLE. 
  

As you may have guessed, the second clause will cost you significantly more than the first one as the borrower is paying interest on top of interest almost immediately rather than only ONCE at the end of the deferment period.    How much more?  With a $10,000 loan taken out in fall semester of your freshman year with an average interest rate of 10%, a loan that adds accrued interest to principal on a quarterly basis COULD COST YOU $1,500 MORE OVER THE LIFE OF THE LOAN!

So, what can you do about this?

• Eliminate this issue of accruing interest altogether by repaying the interest on your loan on a monthly basis while you are in school.  This will not only help you build a positive credit history but will allow you to leave school only owing the principal amount on your loan (i.e., the amount you borrowed) rather than allowing interest to accumulate and be added to your principal.
  

• Choose lenders that only capitalize interest ONCE just prior to your repayment on the loan.   
  

The fine print does matter!  Good luck and please share this information so others can save money on their student loans too.