This is the second in a series. Yesterday’s post offered guidance on effective ways for parents to talk to their young adult children about school-related financial issues.
Most college students use student loans to help pay for their education. There are still some families (including moderate-income families) whose children complete college without any loans — through a combination of money saved up over the years, plus scholarships and earnings from a job — but that is not the norm. So if you are expecting to rely on student loans, you are pretty typical.
While student loans create valuable opportunities, they can contribute to problems if they feel like “easy money.” It seems easy to some students: just sign the paper, and the money is yours. It is years later (or even decades later), as they repay the loans, when some students understand that loans are far from “easy money.” Students start out a step ahead if they recognize that reality from the get-go.
Two key strategies exist for reducing the “payback pain” of student loans:
- borrow less – as little as you can
- Choose your loans wisely. (Yes, you have choices — shop around!)
Here are some tips to get you started with that.
In general, Federal Student Loans are the most desirable type – low fixed interest rates, and a range of repayment options. Best of all are Federal subsidized student loans, available to some students based on need. Subsidized means the government pays the interest for you for as long as you are a student (more than half time); that’s a huge bonus. Example: a student who borrows $5,000/year for 4 years with a subsidized loan will have a starting loan balance of $20,000 when they graduate. By contrast, if that was an unsubsidized loan, interest would accrue even while they are still in school. If the interest rate is 4%, their starting loan balance when they graduate would be $22,081, because of the interest charged for those four years of borrowing.
A student’s eligibility for Federal Student Loans, and the maximum amount they can borrow, is determined by their financial aid application (FAFSA), and is part of their financial aid offer from the school, which may also include scholarships and grants. When students need to borrow more than they are eligible for in Federal loans, that is where the shopping around comes in.
Private student loans are offered by private lenders. In general, interest rates are likely to be higher than Federal loans, and the rates are usually variable. You might start out with a low interest rate, but if prevailing interest rates rise, the rate on your loan will probably go up, as well. In some cases, borrowers with excellent credit histories and ability to repay may be offered lower interest rates. A typical student, with little to no credit history, will likely need a co-signer. All of these variables point to the reasons why it is valuable to shop around for student loans. Checking a minimum of three lenders is always recommended.
A third option for families to consider is the Parent PLUS Loan. These are available only to biological or adoptive parents of dependent students; students must be enrolled in school at least half-time. The parents must be credit eligible, although there is a process through the Department of Education by which parents can be approved even with poor credit histories, depending on the reasons or extenuating circumstances contributing to that poor credit score. Parents are responsible for repayment; that means parents must consider their entire financial picture, including their age and retirement plans, the needs of other children, and their ability to maintain satisfactory lifestyle while repaying a loan. These are Federal Loans, administered through the Dept of Education.
As with any important consumer decision, it is critical to use reliable information. Many of the best sources of information are provided by the United States government, beginning with the umbrella website www.studentaid.gov. The Consumer Financial Protection Bureau (CFPB) also offers numerous resources to help with decision-making, including a simple one-page guide to student loans and a very helpful student loan web page. Additionally, another one-page tool helps students make informed choices about bank accounts.
The CFPB offers another comprehensive planning tool titled: Your Financial Path to Graduation. The tool is easy to use, and takes a student step by step through a fairly complete look at the sources of money they have available to cover their college expenses, AND a personalized look at what they can expect those expenses to be. It helps students and families consider various options, and gives them a forecast of what their situation might be by the time they graduate, including what their total debt levels might be and what starting salary they might reasonably expect. I tested it out with a hypothetical student situation, and I thought it could be very helpful – I encourage you to try it!
This is the second in a series this week on student financial readiness for college. Next up: discretionary expenses.