Never overpay for college

Understanding Federal Loans

LoansIn the world of borrowing for college, we finally have some good news for families: The percentage of money borrowed to pay for college, as opposed to the amount of money paid out of pocket, has decreased by five percent!

Here is an “exciting” snippet from the Wall Street Journal citing information from this year’s study by Sallie Mae and Ipsos that explains the change:

“The annual study, now in its seventh year, found that while the average amount spent on college was consistent with prior years, families spent more out of pocket (42 percent of college costs) while overall borrowing (22 percent of college costs) was at the lowest level in five years.”

Now for the inevitable bad news to follow, most in-state public colleges are upwards of $25,000 per year in Total Cost of Attendance, (as determined by the school’s combination of tuition, room and board, books, transportation costs, etc) so the average family is still borrowing considerable money for college. Private schools offer far more financial aid than public schools but also come with a price tag that tops out at around $70,000 per year at the nation’s most expensive schools. Out of state, public schools punish residents for crossing over into their state by charging a tuition that is double or even triple the amount charged to in-state residents. Additionally, this study does not take into account the tremendous interest attached to these loans, both on the backs of the student and the parent(s) that considerably increase the out of pocket expenses for college. Interest is arguably the single biggest issue for the borrower but especially for parents as we will explain shortly.

Student loan debt as a whole has surpassed one TRILLION dollars*. This problem is not going to go away anytime soon but it does not take away from this important reality today: Student’s borrowing power alone is minimal compared to the overall cost of college. The following explains what students can actually borrow for college**:

First Year: $5,500 maximum Student Stafford Loan ($3,500 subsidized*** max and at least $2,000 unsubsidized) Second Year: $6,500 max Student Stafford Loan ($4,500 sub max and at least $2,000 unsub)

Third Year and all subsequent years of undergrad: $7,500 max Student Stafford Loan ($5,500 sub max and at least $2,000 unsub).

This means that he best case scenario for students looking to borrow the max, (based on four-years of college), is $27,000, $19,000 of which may be subsidized. Income plays a considerable role as to how much of the money will actually be subsidized but many students will have more than $8,000 in unsubsidized loans to cover over the four years.

As far as interest rates are concerned, current students are borrowing at a rate of 4.66% both for unsubsidized and subsidized loans. This number is re-visited every two years by Congress. A 1% origination fee is also charged for all federal Stafford and Perkins loans. Extenuating circumstances can provide further relief but most families with a household income of $30,000 or above must play by these rules (some families below $30,000 still are ineligible for further benefits).

Beyond the aforementioned, the rest of the money that can be borrowed for college is on the parent’s dime, either via Parent Loans or Private “Student” Loans that require a co-signer. Hint: Students are not the ones that are truly on the hook for the payments on these loans, a private lender isn’t foolish enough to expect college students to cover these high costs. This point cannot be understated, Private “Student” Loan payments are mostly incumbent upon the co-signer, not the student to cover. It is true that some private lenders provide an opportunity for the co-signer to be released from the loan but this option is not exercised easily or quickly.

The Federal Government as well as both public and private institutions encourage families to apply for the Federal Parent Plus Loan to cover any additional borrowing. These loans are solely the responsibility of the parent(s) and are designed to have a lax approval process in comparison to private loans. Parent Plus Loans are a very common and very tough pill for families to swallow as these loans have a current fixed interest rate of 7.21% which began on July 1, 2014. This rate of course is nearly 75% higher than the Stafford Loan and should be considered a last resort borrowing option.

Identifying the right private loan is often preferable if the parent(s) can be approved or if a parent(s) co-signs on a student loan. Interest rate, payment options and origination fees are all areas to look at when determining which lender to work with. Regardless of what route a family in need takes, it is imperative to understand all the available loan options, both from the federal government and private sector. Despite the improving averages above, many families are not able to borrow just 22% of the cost of college. As the previous information clearly indicates, it is the parent that really needs to borrow the bulk of the money, regardless of how astronomical the total student loan debt is in America.

*This figure includes all levels of education, including graduate, law, medical schools, etc.

**Two caveats exist in which some students can borrow additional money from the federal government without a co-signer. Firstly, some low income families qualify for an additional Subsidized Perkins Loan of up to $5,500 (very rare to receive even close to this amount of money) at a set interest rate of 5%. The other scenario is when a family applies for the Federal Parent Plus Loan and is denied. In this case, the student can be offered an unsubsidized Stafford Loan that is equal or less than the amount that an independent student would receive. The school plays a critical role in deciding when to award Perkins Loans and how much additional they will offer a student whose parent(s) cannot acquire a Parent Plus Loan.

***Subsidized loans have interest subsidized or covered by the government during the college years and interest does not become the student’s responsibility until six months after graduated. Unsubsidized loans have interest that kicks in immediately and is the sole responsibility of the student.