Education
Student Loans: Read This Before You Borrow
Federal loans are better than private, and the kids should borrow first
Total loans to students and their well-meaning parents have grown to more than $1.5 trillion, from less than $600 billion in 2007. Family stress levels often rise alongside debt levels.
Parents paying off college loans often find themselves having to skimp (or skip) saving for retirement. Many college students emerge from school with so much debt they struggle to pay bills and get their finances in shape to land a mortgage. Too often, career choices are made to pay off the debt rather than follow one’s passion.
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If your household has yet to hit the college years, a solid plan can help your entire family emerge from the college years in control of their futures.
That starts with understanding the three main types of college loans:
- Federal student loans
- Federal parent (PLUS) loans
- Private student loans
Remember this: Federal loans are better than private loans. Federal student loans should be used before federal PLUS loans.
Federal student loans:
Available to everyone regardless of income: Yes
Credit check: No
Free Application for Federal Student Aid (FAFSA) form required: Yes
Fixed interest rate: Yes
Loan limits: Yes. Range from $5,500 to $7,500 a year
Flexible repayment options: Yes
Federal loans, also known as Stafford loans, are available to every student regardless of family income. Qualifying for income-based aid may also get you a “subsidized” Stafford loan, where the government covers interest payments while the student is in school. With an unsubsidized Stafford, the student is responsible for all interest payments, and interest is charged while the student is in school. Many students opt to roll those payments into their loan balance – this is called capitalization – and not make payments until after they are out of school.
Have the student borrow first, because the fixed interest rate is lower than the fixed rate on federal PLUS loans. Having the kid borrow give you pause? C’mon, a bit of skin in the game can be worthwhile. You can always help them repay the loan.
The standard repayment period for student loans is 10 years, but there are options that can reduce monthly payments – tying them to income – and extend the payment period to as many as 25 years. Certain public-service jobs qualify you for debt forgiveness after 10 years of on-time payments. (A separate program helps teachers.) If the borrower dies, all debt is forgiven.
All students must begin repayment within six months of leaving school. Even if you’re not yet employed, you must start repayment or apply for loan deferment or forbearance.
Federal PLUS loans
Available to everyone regardless of income: Yes
Credit check: Only to confirm you don’t have debt payment issues or a recent bankruptcy
FAFSA required: Yes
Fixed interest rate: Yes
Loan limits: No. Can be up to the full cost of college, minus any aid
Flexible repayment options: Yes
Parents can borrow from the federal PLUS program. The loans are fixed rate, but the rate is always higher than on student Stafford loans. There is also a steep “origination fee” of more than 4%.
A big risk: There is no check on whether you can actually afford the loan – no income check, no examination of your overall debt picture, no one asking if taking out this loan will make it impossible to stay on track with other goals, such as retirement savings. So, you need to ask those questions of yourself.
Repayment begins immediately after obtaining the loan. Like Stafford loans, there are repayment options. Any remaining debt is forgiven when the borrower (that’s you, parent) dies.
Private student loans
Available to everyone regardless of income: Yes
Credit check: Yes
FAFSA required: No
Fixed interest rate: Not necessarily. Adjustable rate is the norm
Loan limits: No
Flexible repayment options: No
These should only be used as a last resort. They’re not automatically forgiven when the borrower dies, so a lender could collect from your estate.
The initial interest rate on an adjustable rate loan can seem enticing. But remember: It’s adjustable. If rates in general rise, so too will your loan rate. If you miss a payment, or break any rules, the lender can increase your rate.
Terms will depend greatly on your credit score. College students typically have yet to build a solid credit score, so they will need a co-signor. A parent who co-signs (or takes out the private loan directly) will be on the hook for repayment. And the loan can cause your credit score to fall – after all, you now have more debt – and impact your ability to borrow for your own needs.
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