Because many lenders are eager to provide loans to college kids, you’ve got to wonder why any school would allow one competitor to dominate. Some schools explained that one lender was clearly the superior choice, so its students gravitated to it. But the discovery sure seemed to mock the notion of comparison shopping.
In its letter, the federal government didn’t accuse the schools of
lawbreaking, but the list did inflame the worst fears of student loan industry
critics who have watched one school after another get caught
with its hand in the cookie jar. As mentioned in Chapter 44, “The Student
Loan Fiasco,” investigations have revealed that some colleges
and universities—no one knows the exact number—have been selling
out their student and parent borrowers for their own gain.
If you must borrow, there are proven ways to cut your costs. Just
as important, you’ve got to know which loans are worth pursuing.
Here’s what you need to understand to protect yourself:
Use federal loans first. Federal loans are the superior choice for
families. Unlike private loans, federal loans offer lower interest rates
and fixed monthly payments. What’s more, federal loans offer repayment
plans based on a graduate’s income, deferments for financial
hardships, and cancellation provisions if the borrower dies or becomes
totally and permanently disabled.
Here are the main federal loans:
Stafford loans. These loans come in two flavors—subsidized and
unsubsidized. The subsidized Stafford, reserved for needier students,
is more attractive because the government pays the interest while the
student remains in school. To get an idea of who qualifies, about twothirds
of students with subsidized loans have adjusted family incomes
of less than $50,000, while a quarter of students have family incomes
up to $100,000. Less than 10% of students with subsidized Staffords
have family incomes that exceed $100,000. In contrast, the unsubsidized
Stafford is available to students regardless of their parents’ income.
Unfortunately, many families won’t be able to borrow all that they
need through a Stafford loan. The government has received a lot of
flak for maintaining a low Stafford borrowing ceiling. Most freshmen
and sophomores can only borrow up to $3,500 and $4,500, respectively,
while juniors and seniors can obtain $5,500 each year.
PLUS loans. While Staffords are reserved for student borrowers,
the Parent PLUS loan, which is also federally backed, is designed for
moms and dads. Parents can borrow enough to meet the cost of a
school’s attendance that isn’t covered by their child’s financial aid
package. Unlike a Stafford, there is no set borrowing limit. While
Stafford loans provide a grace period before payments are required,
parents must start repaying the PLUS debt up to 60 days after the loan
is fully dispersed.
Parents who own homes should compare the fixed rate of a PLUS,
along with its fees, with another alternative—a home equity line of
credit. They also need to plug potential tax breaks into this equation.
Parents can deduct home equity interest off their taxes if they
itemize, but they may also qualify for an above-the-line tax deduction
for college loan interest even if they don’t itemize.
For parents who don’t own a home or who have little home equity,
the PLUS Loan is a no-brainer compared to signing a private loan,
which should be your last resort.
Let students borrow first. Even if parents intend to borrow for
college, it’s always better for the student to take out a federal loan in his
or her own name first. Why? Stafford loans offer a lower interest rate
than the federal PLUS loans. The maximum rate for a Stafford was recently
6.8% versus 8.5% for a PLUS. Beginning in the summer of 2008,
the rate became even lower for subsidized Staffords and the interest
rates will continue to shrink for these undergraduate borrowers.
Although your son or daughter is responsible for the payments,
you can reimburse the child. Young college graduates are more likely
than their parents to be eligible to deduct student loan interest off
their yearly income tax returns.
Look beyond the preferred list. To make shopping for loans
more manageable, many schools compile a list of preferred lenders. A
school could maintain a list of lenders for Stafford loans, PLUS loans,
private loans, and consolidation loans. Colleges are expected to select
lenders for these lists that offer students the best deals on interest
rates and/or customer service or other factors.
By now, you can probably appreciate why you shouldn’t automatically
assume that these preferred lists are stuffed with tremendous
deals. Ask a school’s financial aid administrator why lenders made the
cut and use these names only as a starting point since you can borrow
from any lender. You’ll want to ask about interest rates, fees, customer
service, and any interest rate discounts. As of July 2008, federal regulations
began requiring that colleges put at least three lenders on their preferred lists.
Understand federal loan differences. Not all colleges generate
preferred lists because they participate in a direct federal loan program.
About 20% of schools offer their students federal guaranteed
loans directly from the U.S. Department of Education through the
Federal Direct Student Loan Program. All other students receive federally
guaranteed loans through private lenders via the Federal Family
Education Loan Program.
Your choice will be easy if the school you attend participates only
in the federal direct loan program. At these schools, there is one loan
option, which is the same for everybody who borrows this way. (About
30% of direct loan schools also participate in Federal Family Education
Loan Program.) In the early days of the direct lending program,
many more schools participated, and this competition worried the private
lenders. To protect their territory, the outside lenders began offering
perks to schools to encourage them to shun the direct program,
and it worked. If a school is in the FFEL program, its students can
borrow money from countless financial institutions that participate in the program.
Direct loans became available in the 1990s when President Bill
Clinton and others concluded that it would save taxpayers a lot of
money if the government lent the cash to students without a middle
man. It costs the government more when students borrow from outside
lenders, but obviously families are worried about their own costs,
not the federal government’s financial problems.
Many students might prefer sticking with direct federal loans for
a compelling reason: Only direct loans provide a financial safety valve
that allows borrowers who choose lower-paying careers to make
monthly payments based on their income, which can be worth its
weight in gold.
What’s more, a feature called the income-contingent repayment
allows the monthly payments to be calculated based on the size of the
loan, as well as the former student’s salary and family size. These loans
can’t drag on for more than 25 years because if they haven’t been paid
off by then, the debt is canceled. If debt is forgiven, you will owe income
taxes on the forgiven amount, but that’s obviously a long way off.
As of July 2009, however, borrowers of Stafford loans and Grad
PLUS loans, which are strictly for graduate students, can also choose
a newer feature called income-based repayments. While it’s similar to
the income-contingent plan, the new alternative results in lower
monthly payments. By choosing income-based repayments, borrowers
will limit their repayments to 15% of their yearly discretionary income,
which is defined as the amount by which adjusted gross income
exceeds 150% of the poverty line. What’s more, direct loan borrowers
who work full time for at least a decade in public service jobs, will have
their loan forgiven after paying it off for 10 years. Other borrowers can
qualify for public service loan forgiveness by consolidating their loans
into the direct loan program.
While outside lenders can offer income-based repayments, it’s unclear
how many of them will. If a private lender doesn’t, however, a
borrower is entitled to obtain a federal direct consolidation loan on the
grounds that his or her lender didn’t provide the new feature.
Evaluate repayment plans. Student loans typically offer a
handful of alternatives to repay the debt. The traditional way requires
a borrower to begin writing checks that cover the loan’s principal and
interest right after the loan has been made. You can usually capture
the lowest interest rates with this option.
Another alternative is simply making interest payments until after
graduation. Borrowers who are saddled with the higher rates and fees
are those who delay paying anything until they’ve graduated. The
monthly payments will also be higher because the unpaid interest
that’s been accruing will be dumped back into the loan.
Be realistic. This may sound cruel, but if you aspire to be a social
worker or a painter, you probably shouldn’t borrow as much as a future
dermatologist or investment banker. Here’s a handy rule of
thumb: Don’t borrow more than your anticipated starting salary after
you graduate. If you borrow more than twice your starting salary, it’s
likely you will be in extreme financial difficulty and will struggle to
make the monthly payments. Borrowing too much for an education
can be even more perilous for students who end up in trade schools.
Action Plan
Always choose federal loans first and avoid private loans.
Source: The College Solution: A Guide for Everyone Looking for the Right School at the Right Price
