The smart way to borrow for college needs to begin with a plan. Too often families turn first to loans to fill in the gap for the high cost of a college education. Taking on too much debt to pay for college will burden parents and their children as the former try to fund retirement and the latter try to launch careers and lives of their own. Consider these tips on ways to make smarter choices when it comes to loans.
Find the Right School
The first and best way to handle borrowing for college is to minimize it. By finding schools that offer a high percentage of financial aid in the form of grants or discounts off the sticker prices, you’ll minimize the amounts that you’ll need to borrow. Schools publish the average amounts of aid awarded and the percentages that are outright ‘gift aid’ that doesn’t need to be repaid versus aid in the forms of college loans that do need to be repaid. Do your homework and ask the financial aid office or tap into specialized databases available to college funding advisors.
Take Federal Loans First
Federal loans offer the most flexibility with terms and should be the top of the list on smart ways to borrow for college. These loans allow students to borrow money during college without needing to start repaying until after graduation. Interest accrual starts after you leave school. And if you have difficulty making payments there are a number of arrangements to change the repayment schedule or postpone repayment during periods of hardship like unemployment.
Perkins Loans
These are needs-based loans with current fixed rates of 5%. Undergraduates can receive up to $5,500 per year up to $27,500 over the course of your undergraduate degree. And you’ll have up to nine-months after leaving school before repayments begin with a 10-year repayment period.
Direct Subsidized Loans
This is another needs-based government-sponsored loan program. Loan interest is paid by the government while you’re still in school. The current fixed rate is 4.66% but is reset for new loans beginning each July 1. Once a student qualifies for the loan program she can borrow up to $23,000 for an undergraduate degree and all loans will have the same interest rate assigned based on the rate when the first loan was accepted.
Alternative Loan Sources
State Loan Programs
While not every state offers loan programs, many do and these should be part of your search. You’ll need to shop around and compare these options with those that may be available through private commercial lenders but it’s worth the effort to check them out.
Home-Equity Line of Credit
With interest rates so low and home equity increasing for many homeowners, using your home equity may be another smart way to borrow for college. Rates on these loans are usually less than those available through private or parent student loans like PLUS. And the interest may be tax-deductible which is not the case for many other student loans. In fact, for most student loans you’re capped at the amount of student loan interest that may be deductible at $2,500 and the tax deduction only applies if your income is at or below certain thresholds. Not the case for a HELOC.
And the HELOC doesn’t impact your financial aid calculations on a FAFSA or CSS Profile form like a regular cash-out refinance or home equity loan will. With these latter options you may find that having the cash proceeds sitting in the bank when it comes time to file financial aid will hurt your Expected Family Contribution or EFC, the main financial aid calculation for aid. Why? Because while home equity is for the most part not an assessed asset for the EFC, cash in the bank is.
Student Loan Repayment Plans
Almost all student loans come with a default repayment period of ten years. By paying the student loan off in that time you’ll save on the total cost of loan interest over a longer repayment period. This is just like the total cost of repaying your home loan over thirty years will be much higher than if you paid it off over 15-years.
But while that makes sense it may not be financially feasible to repay your student loans in that time period while also trying to launch a career, save to buy a home, get married or raise kids.
Extended Repayment Plan
Aside from the 10-year standard repayment option, you can opt for the extended repayment plan to reduce your monthly payments and have a repayment term up to 25 years. This option works with both subsidized and unsubsidized federal loans and PLUS loans. You’ll need a minimum of $30,000 in loans to qualify.
Income-Based Repayment Plan
With an income-based repayment plan your loan payment is tied to what you can afford based on a federal formula. If your debt is a high percentage of your income, you may qualify to have your loan payments capped at up to 15% of your ‘discretionary’ income. The payments will be less than the 10-year standard repayment plan. And after 25 years of income-based repayment, you’ll have any remaining outstanding balance forgiven. This option works for federal subsidized and unsubsidized loans but not for parent PLUS loans.
Pay As You Earn Plan
This newer program is more generous since your maximum payments are capped at 10% of your discretionary income. You’ll have the remainder of any loans forgiven after 20 years of solid repayment history.
For more information on these options you can check out www.studentloans.gov or call a qualified college financial planner.
