Recently, concerns about student loans have been in the headlines. In 2015, the Federal Reserve Bank of New York put total student loan debt at $1.16 trillion, greater than outstanding auto loans or credit card balances. Publications such as the New York Times have published articles about “A Generation Hobbled by the Soaring Cost of College.”
The reason for the growth in student loan debt is straightforward: Many families need to borrow money in order to cover the expense of higher education. If you’re in that situation, knowing your choices can help you make practical decisions.
Today, most higher education loans come from the U.S. Department of Education. Broadly, they fall into one of two categories: student loans or parent loans.
The most common federal loans, formerly known as Stafford loans, are now called Direct Loans. Students are the borrowers; in order to be eligible for these loans (in fact, for any federal education loans), the student must fill out the Free Application for Federal Student Aid (FAFSA). There is no credit check, but there are limits on how much students can borrow. Typically, annual loans to undergraduate students who are parents’ dependents can be as large as $5,500 for freshmen, $6,500 for sophomores, and $7,500 for others.
Besides an origination fee of approximately 1% of the amount borrowed, Direct Loans have fixed rates, set each summer, based on then-current interest rates. As of July 2015, the fixed rate for Direct Loans is 4.29%.
Direct Loans are either subsidized (for students who demonstrate financial need) or unsubsidized. If a student has an unsubsidized loan, payments are due after the funds are disbursed. Borrowers can choose not to make payments until six months after leaving school, but all unpaid interest will be added to the loan balance. With subsidized Direct Loans, the federal government pays the interest until six months after the borrower leaves school.
Students with exceptional financial need may qualify for a federal Perkins Loan. If so, no interest will be charged until nine months after leaving school. The fixed interest rate is 5%, and loans to undergraduates go up to $5,500 a year.
For federal student loans, the standard repayment period is 10 years, but there are various extension, deferral, and even loan forgiveness opportunities. For example, some loans can be forgiven if a borrower teaches full time for at least five consecutive years in a school classified as “low-income” by the Department of Education.
Formerly known as Parent Loans to Undergraduate Students, federal Direct PLUS Loans are offered to parents of undergraduates. (PLUS Loans also are available to graduate students.) Again, a student must fill out the FAFSA in order for a parent to get a PLUS Loan. PLUS Loans can be as large as the total amount of college costs, minus any financial aid.
Example: Dave Evans attends a college where the posted cost of attendance is $40,000 for this academic year. Including a student Direct Loan, Dave receives financial assistance that totals $16,000. Thus, Dave’s parents can borrow up to $24,000 ($40,000 minus $16,000) with a PLUS loan for that year.
The origination fee for a PLUS Loan is 4.292% (4.272% on or after October 1, 2015), and the fixed interest rate is 6.84% for the 2015–2016 academic year. In order to receive a PLUS Loan, a parent must pass a credit check. If the parent’s application is rejected, the child may be able to receive larger student loans.
Although most student loans come from the federal government, some banks, credit unions, and other lenders offer education loans as well. Private loans can supplement or even replace federal education loans. Interest rates on private loans can be lower than federal rates for creditworthy borrowers—some are in the 3% range now.
However, private loans often have variable rates, which can rise if prevailing interest rates move higher. Private education loans may have relatively high fees, so borrowers should read all the fine print before making any decisions. Our office can help you determine the true cost of a private student loan you’re considering.
Keep in mind that any loan can be an education loan, if the proceeds are used to help pay college bills. You might use a home equity loan or a home equity line of credit, for instance. Besides a relatively low interest rate, home equity debt may offer more opportunities to take a tax deduction for the interest you pay. Of course, you always should use home equity debt with caution because your home might be at risk if you default.