How to pay for college with loans – Being a smart borrower
By Joe Messinger, CFP®
July 28, 2017
Families often wonder how to pay for college with loans. How to make the right choices? How to make smart plans for the future?
According to StudentLoanHero.com in 2017, Americans owe $1.44 trillion in student loan debt with 44.2 million borrowers. Some staggering numbers!
For most college-bound families, student loans are part of the picture when paying for college. Nearly 7 in 10 students graduate with some form of student loan debt. The reality is the cost is just too high. They have a gap and loans may be the only way to fill it.
What do you need to be aware of?
First, know the total cost for all four years down to the penny. You can’t plan without seeing the whole picture. With the total amount calculated, consider if your assets, scholarships, grants, cash flow, and tax credits can cover that number. If not, you have gap.
Federal vs Private Loans
So, how do you bridge that gap? In a recent blog, we talked about the importance of using federal loans first. Federal loans need to be your first stop shop when filling your gap.
We like to refer to them as “use it or lose it” loans. Loan amounts are capped each year so don’t wait to take advantage of them. Our blog has a great explanation and graphic of what we mean.
We like to suggest that private loans are a last option for families. Families run into trouble later when they take excessive private loans.
A Quick Comparison
|Federal Student Loans||Private Student Loans|
|In student’s name - no co-signer needed||Co-signer required|
|No credit check needed||An established credit record is required and will determine the interest rate|
|Payment deferred until after leaving school||Payments may be due while in school|
|Fixed interest rate - lower than private rates||Variable interest rates - some over 18%|
|Loans can be consolidated||Loans cannot be consolidated, but may be able to refinance|
|Options when you have trouble paying||May not offer forbearance or deferment options|
|Government may pay your interest while in school if you qualify for subsidies||No subsidies of interest|
|No prepayment penalty||May have prepayment penalties|
Finally, federal student loans offer repayment and forgiveness plans that private lenders may not offer. Federal loan forgiveness for teachers, public service, etc. is sometimes talked about for private loans, but we doubt it will ever happen. Repayment plans, a benefit of federal loans, let you make payments based on your income.
Private loans rely on the credit record of the co-signer. Interest rates will vary based on their credit rating. Students have no track record of handling debt and their ability to pay is an unknown to the bank so the co-signer is key.
Parents with bankruptcies or other credit problems in their past will face difficulty getting a loan. Even Parent PLUS loans are subject to credit worthiness considerations.
Are loans transferable to others?
Parents mistakenly believe that Parent PLUS loans in their names can be transferred to their student after graduation. Parents cannot transfer their PLUS loans. Mom and dad continue to be responsible for that loan themselves.
Similarly, co-signer parents or grandparents on private loans will remain on those loans until their graduate establishes good credit at some point later in their work experience.
On the flip side, federal loans (non PLUS) are issued in the student’s name. They help your student build a good credit record.
If the student passes away, the federal loan (incl. PLUS) is discharged. Private loans on the other hand typically remain the responsibility of the co-signer. Read the fine print.
Knowing the down sides, how do you get a private loan?
First stop is always the financial aid office of the college. They may have a list of preferred lenders to recommend. Take these recommendations with a grain of salt. They may not always be the best option for the consumer, but they are a good place to start. The lender is up to you. You do not need to stick with the college’s list.
Compare products when making your choice!
- Interest rates (fixed vs. variable)
- Total cost of loan
- Fees (including Origination)
- Repayment terms if available
- Credit requirements
- Academic progress requirements
- Lender reputation
- Customer Service
Home sweet home?
If parents are looking at ways to finance college, they may want to consider a home equity line of credit–only after the federal direct student loans! If you have good credit and equity in your home, this strategy may offer a better interest rate and typically the interest is tax deductible.
Proceed with caution though. Being mortgage free at retirement is a beautiful thing so don’t forget to understand the impact that financing a college education has on your retirement outlook.
Some final thoughts…
Don’t be the statistic! “Consumers age 60 and older are the fastest growing age-segment of the student loan market.” These loans are being taken out for kids and grandkids. Try through careful planning and utilization of all options available to avoid these private loans that are causing the real student loan debt crisis in America.
You probably have a gap between what you have and what you want to spend, but through careful college selection and the proper knowledge of how to pay for college with loans, your student can leave college with a manageable amount of debt.
Our rule of thumb is you should never take out more in total debt for your education than you anticipate making your first year out of college in your chosen career.