Chris Farrell: With student loans, flexibility trumps the interest rate

Q We have two daughters, 18 and 14, and are in our early 50s. Our eldest is heading off to college in Wisconsin this fall, and we're fortunate to be employed and relatively debt-free. With reciprocity, the cost of tuition, room, board, books and miscellany is estimated at $22,000 per year.

To pay for it we have 14 percent in a college fund (Coverdell and UTMA), 16 percent as student's contribution (working or scholarships), 45 percent parents' contribution, and after FAFSA (Free Application for Federal Student Aid), our student qualified for a 25 percent unsubsidized Stafford loan.

Although I don't want to saddle our child with debt, today's reality is that it's necessary for those attaining a higher education. My goal is to help her keep the debt manageable. Thus, I have three options on the student loan portion:

•Accept the unsubsidized Stafford loan. This is a fixed-rate loan at 6.8 percent; interest can be paid or deferred until after graduation and capitalized, plus it has affordable repayment plans.

•Get a student education loan through her bank with a variable rate; the lowest rate is at prime plus 1.95 percent (5.2 percent), with a cosigner, or prime plus 4.95 percent (8.95 percent), where the interest can be paid or deferred.

•Access our personal line of credit. The rate is variable at prime (now 3.25 percent); the interest is paid monthly. In the past, if my spouse and I needed to borrow, we chose the lowest interest rate. But under this circumstance, is it the best route?

KATE, EDEN PRAIRIE

With student loans, the interest rate isn't the key consideration. What really matters is financial flexibility. Who knows what the economy will be like when your eldest daughter graduates from college? Jobs may be plentiful or scarce.

That's why I think the unsubsidized Stafford loan wins hands down. The loan terms are flexible with several repayment options. For instance, the standard student loan repayment plan is a fixed monthly payment for 10 years. But if she needs financial relief, she could opt for a graduated repayment plan, an extended repayment plan or an income-based repayment plan. If she lost her job or had a serious illness after graduating, she could even put the loans for a time into deferment or forbearance.

All these choices come with a price tag: Upfront financial relief increases the overall cost of borrowing. However, when financial circumstances improve, borrowers can always accelerate their student loan payments. There is no prepayment penalty with student loans. What's more, depending on her income after she graduates, you could always help out with the loan payments if that made sense for both of you.

Not everyone agrees with me, but I don't think private student loans should be called student loans. It suggests that they're similar to federally sponsored student loans, and it isn't the case. In essence, it's a straightforward consumer loan with monthly minimum payments and limited flexibility. There are a few avenues for nicking away at payments. For instance, most lenders will offer a better rate with a cosigner (but that's a bad idea for the cosigner.) Borrowers often get a small interest rate reduction for setting up automatic monthly payments. That's pretty much it.

I would steer clear of borrowing against your home equity to help pay for her college. We all learned the hard way during the real estate boom and subsequent bust that home equity loans are too risky, especially when compared with federally sponsored student loans. Good luck.