States expand student loan options as new federal borrowing caps take effect — but they come with trade-offs — CNBC

RESOLVING THE LEDGER

As borrowers come up against new federal limits on student debt, they may encounter financing options from an unexpected source: their state.

But don't assume these government-backed loans are a close substitute for federal student loans . Consumer advocates say state student loans are more akin to private student loans , and should be approached with caution.

"While state loans can be an important option for some borrowers, students should understand the trade-offs and risks before assuming they're equivalent to federal loans," said Tiara Moultrie, a fellow at The Century Foundation, a left-leaning think tank. "The government label can obscure the fact that state loans function much more like private credit products."

States have had their own student loan offerings for decades . Several — including Connecticut , Massachusetts , Minnesota , Pennsylvania and Rhode Island — have recently moved to expand their loan offerings in anticipation of the added restrictions on federal borrowing.

Under President Donald Trump 's "big beautiful bill," starting July 1 , new graduate students became subject to an annual federal student loan cap of $20,500 a year. Those pursuing a professional degree in law, dentistry or medicine, among other programs, can take out up to $50,000 annually. Previously, graduate students could borrow as much as they needed.

Some states mention the recent federal limits in the advertising of their loans. Earlier this year, a bipartisan group of senators also introduced a bill that would make it easier for colleges to recommend state student loans, which are typically backed by state government agencies or nonprofit state organizations.

Advocates have said that the federal loan caps could push more borrowers to private lenders such as SoFi and Navient . Changes in the state lending space have the potential to divert some of those borrowers.

Interest rates on state education loans vary by state, and can also depend on the degree program and borrower qualifications, such as income and credit score. The top end of the range can be quite high, even if they're cheaper than private student loans, said Rich Williams, a former deputy assistant secretary at the Education Department.

"Most of these programs are financed by bond sales, not state appropriations, so the program has to generate returns for bondholders," Williams said.

Interest rates on some state student loans can exceed 10%, according to a July analysis by The Century Foundation. For example, in Pennsylvania, rates can range from 3.29% to nearly 10.5%, they found.

For comparison, the U.S. Department of Education's Direct Unsubsidized Loans for graduate and professional students currently come with a flat interest rate of 8.07% .

"We know the new federal borrowing caps threaten to limit how much graduate students can finance for advanced degrees," said Bethany Yenner, vice president of public relations, communications and marketing at the Pennsylvania Higher Education Assistance Authority, or PHEAA, an organization that administers state and federal financial aid programs. "We're stepping in where federal aid may fall short."

To be sure, state student loan interest rates can be much lower than those on private student loans — which can run more than 20% , according to NerdWallet.

Some states, including Louisiana, offer student loans specifically for parents . These loans can have lower interest rates than the federal government's Parent PLUS loan, which currently has an interest rate over 9% .

Gail daMota, president of the Education Financial Council, a trade group representing state lenders, said a state-based education loan will not be the best option for all students.

But, daMota said, "borrowers should at least be aware of their existence, understand what they offer and compare options as it may be the most affordable for them."

Consumer advocates recommend students first exhaust free aid like grants and scholarships before turning to federal student loans. Private or state-backed loans should be a last resort, they said, as needing them often signals overborrowing .

Borrowers may struggle to qualify for state student loans, said Williams, chief customer officer at student loan advisory firm Summer.

"Some state programs require high credit scores, which locks out a large share of the borrowers who most need the help," Williams said.

Often, borrowers need a credit score above 700 to avoid a co-signer requirement with a private or state-based lender, said Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade group for student loan servicers. A co-signer is someone who is equally financially and legally responsible for the debt.

"Those who have low or no credit score will often need to find someone to help co-sign the loan," Buchanan said.

In some cases, getting a co-signer can lead to better terms, even if it's not required. For example, the website of a state student loan program in Minnesota states that lower interest rates are offered to borrowers with a co-signer .

Parents, grandparents and anyone else considering being a co-signer should understand what doing so involves, Moultrie said. Only a few state loan programs offer co-signers a way to be released from the loan.

State student loan programs usually have residency rules, too, Buchanan said.

"Most state-based student loans require a direct connection to the state itself, meaning that either you are a full-time resident or attending a college or university in that state," Buchanan said. Though he added, "a handful of programs lend across state lines."

It's important that borrowers also understand that state student loan programs are excluded from federal relief options and protections, Moultrie said.

That means you won't be able to repay a state loan through the Education Department's Income-Driven Repayment plans or qualify to have the loans canceled under Public Service Loan Forgiveness . PSLF is a popu...

States expand student loan options as new federal borrowing caps take effect — but they come with trade-offs — CNBC | AIPROPX