A constant fear of a myriad of our clients is determining how to pay for their children’s college. Unfortunately, many Americans need to begin very early in order to properly fund 529 plans/UTMA accounts. However, the sad fact is that most parents aren’t saving enough for college. In Fidelity’s annual college savings study, parents plan on saving 70% of the total cost of their children’s college education. Unfortunately, the cover under a third (29%) of their savings goal, which is down from 34% when we wrote this article 3 years ago. Thus, many families need to look elsewhere, and this may mean student loans, which are currently at record highs. At the end of last year, outstanding student-loan debt hit $1.3 trillion at the end of 2016, up $220 billion from 2013, according to the Federal Reserve Bank of New York. What’s more, currently, more than one in 10 student loans (11%) are more than 90 days delinquent— a higher rate than for auto loans, credit cards or mortgages. Thus, the question is, if loans are a necessary evil, what are the options? I have ranked the options below.
Direct Subsidized Loans: - (Stafford)
The direct subsidized loans are clearly the best option of the lot, for several reasons. First, the interest rates are the lowest by far; for Stafford loans, the rate (as of July 2017) is just 4.45% (variable rate) for undergrads (based on the 10 year treasury note), with an origination fee (one time) of 1.068%. Also, interest does not begin accruing while the student is in school/deferment. All that is necessary is that your child is enrolled at least part time and meet very basic eligibility requirements required for all federal loans (HS diploma, have a SS number, are not in default of any loans, maintain satisfactory academic performance, etc.). The downside, however, is that you must demonstrate financial need in order to be eligible for this particular program. Also, the loan amount is not substantial – it ranges from $3,500 to $5,500, which depends on your year in school (there are also aggregate limits of $23,000). Unfortunately, such loans will probably only cover a fraction of the first year’s cost, and do not allow for grad school education. However, if your student is eligible, this is the best place to start.
Direct Subsidized Loans: - (Perkins - EXPIRING)
This would typically be the next place to go. These loans are very similar to the Stafford loans, but the interest rate is slightly higher at 5% (fixed rate as of July 2017). Undergrad students are allowed to borrow up to $5,500 (grad students may no longer borrow under this program per 2016 legislation). Like subsidized Stafford loans, Perkins loans do not accrue interest while the student is in school, but again there is a needs based test that must be met. Unlike the Stafford loans, in which the government is the lender, you pay your school back with Perkins loans. Your student must meet basic eligibility requirements, and be enrolled at least part time. Note that Perkins borrowers must first exhaust Stafford eligibility (both subsidized and unsubsidized) in order to receive new Perkins loans unless they are existing Perkins borrowers. This program is set to expire in September of 2017, so apply while you can (although, an extension of the program for an additional two years is gaining steam in Congress).
Direct Unsubsidized Loans: - (Stafford)
If your children do not qualify for the subsidized Stafford Loans or the Perkins Loans, they should be able to qualify for unsubsidized loans. All that is necessary is that your child is enrolled at least part time and meet very basic eligibility requirements required for all federal loans (HS diploma, have a SS number, are not in default of any loans, maintain satisfactory academic performance, etc.). The interest rate is the same as the Stafford subsidized loans (again, a variable rate based on the 10 year Treasury); however, interest does in fact accrue during your academic career. One silver lining is that you do not have to begin paying back the loan until nine months after you graduate. The max you can borrow is also higher, as you have between $9,500 - $12,500 depending on your year in school. Unlike the subsidized Stafford loans, you also have the ability to borrow for grad school as well.
After the Stafford/Perkins loans have been exhausted, the next step would be to have the PARENT take out PLUS Loans (Parent PLUS for undergrad, Grad PLUS for grad). The determination of eligibility mirrors the Stafford unsubsidized loans – thus, there is not a financial need requirement. However, there is a credit check on the parents, and any adverse credit history will knock the parents out of obtaining these loans. The PLUS loans allow the parent to actually borrow the total cost of undergrad education after taking into account the above loans (Stafford/Perkins), which are netted to get the total amount you may borrow. The interest rate is 7% as of July of 2017 (based on the 10 year treasury), and it begins to accrue immediately. Parents must also pay a 4.276% origination fee. PLUS Loans are restricted to the biological or adoptive parents, as well as stepparents of a dependent undergraduate student.
If you cannot qualify for Parent PLUS or Grad PLUS loans, then private loans need to be obtained. Private student loan interest rates are based on borrower credit and come in fixed and/or variable options depending on the lender. Rates can very greatly, from 3% on the low end to 12% on the high end. Thus, this is an option of last resort. If the expense is small in order to bridge the gap, you may want to consider using a HELOC, as traditionally those rates are more reasonable. Of course, this carries drawbacks, as you are putting your home at risk. You may also want to consider taking out a 401(k) loan, as you would be paying yourself back in interest. Again, this is less than ideal, as such monies taken out will not take
part in the market. However, if you get to this stage, this may be more than ideal vs. going the private route. In you must go the private route, a great website to use is http://www.simpletuition.com/ - this website will help you compare loans and get you the best rate.
Next month, in Part 2, we will look at Loan Consolidation of student loans.
In the meantime, if you have any questions, we are always here to help. Feel free to reach out to us!
Karen DeRose and Anthony DeRose are registered representatives of Lincoln Financial Advisors.
Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. DeRose Financial Planning Group is not an affiliate of Lincoln Financial Advisors.