College is expensive; much more so than just 20 years ago. What we all need is as much help in the form of free money (scholarships and grants) as we can get. The problem is not everyone can get enough to pay the entire cost. This is where student loans come into play.
Student loans are a necessary evil for most. Let’s look at what is available:
Private loans. There are commercial lenders who make direct loans for college. Their drawbacks are that most require payments while in school, they can have variable rates, interest in excess of 18 percent, and they are not subsidized in any way. Local credit unions and banks can, many times, offer attractive packages. An upside to this is the establishment or furthering of a local banking relationship.
Other non-governmental loans, include retirement funds or home equity loans. I do not often endorse the former and urge caution in using the latter. One loan to consider is through any cash-value life insurance you may own. This offers maximum flexibility, if done correctly, since you have a lot of control concerning the terms of the loan. You should consider having a professional assist you in this as you do not want to jeopardize the death benefit.
Government loans. To qualify for federal student loans, you must complete the FAFSA (Free Application for Federal Student Aid). I encourage you do so even if you do not feel you will qualify. Many are pleasantly surprised to see that they do qualify for something.
There are two loan programs offered through the U.S. Dept. of Education. These are the Direct Loan Program and the Federal Perkins Loan Program. The Direct Subsidized Loans are available to the student and aid is needs-based and dependent upon income and/or assets for the parent and child. The current fixed interest rate is 4.66 percent, with no interest due until the student has been in “out-of-school” status for six months.
The Direct Unsubsidized Loans are for undergraduate, graduate and professional students. The interest rates are currently 4.66 percent for undergraduates and 6.21 percent for graduate students. Repayment begins when the loan is disbursed.
While the above loans have limits on much you can borrow per year and in the aggregate, Direct PLUS (Parent Loans for the Undergraduate Student) are available, without certain limits, to graduate students, professional students, and the parents of undergraduate students. Financial need is not needed but good credit is. The PLUS loan is not subsidized and the interest rate is 7.21 percent.
For those who currently have student loans, there is a loan consolidation program. The fixed rate for consolidation is based on the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of 1 percent. There is no cap on the interest rate of a Direct Consolidation Loan.
The Direct Consolidation Loan allows students to combine multiple federal student loans into one loan making, generally, payments easier to track and to allow for one payment for all loans. Parent PLUS loans cannot be rolled into the student’s name and become the responsibility of the student.
The Federal Perkins Loan is for undergraduate and graduate students who have exceptional financial need. The amount received depends on other financial aid received and is limited to $4,000 for each year of undergraduate study and $8,000 for each year of graduate or professional study. The interest rate is 5 percent fixed repayments.
Today, total student debt in the U.S. is $1.2 trillion, which equates to $29,400 per college graduate. A major reason is that college tuition has increased 1120 percent since 1978. One in 10 borrowers is defaulting within two years and almost 15 percent within three years. This represents 600,000 borrowers.
Defaulting on student loans is a major problem, not only for the country, but for the defaulter, as well. A student loan cannot be discharged in bankruptcy and can follow you the rest of your life, making it difficult to get auto or home loans, credit cards, or other desired credit. It is important to know that, if loan forgiveness is an option, the forgiven amount is considered income for tax purposes. This could create a large tax bill in the future at a tax rate that is not known today.
It is best to use loans only when needed and to exercise discretion. It does not make economic sense to borrow more than your projected first-year income upon graduation.