Student Loans: Which Loan? Which Borrower?
Students and families intending to borrow for college have a range of choices. The best starting point for borrowing is always the Federal Direct Student Loan. This is the lowest-cost federal loan available, has all of the federal loan protections and best of all, students can take it out without a co-signer, even without any credit history.
But the direct student loan has a low annual cap: $5,500 the first year, $6,500 the second year, and $7,500 for subsequent years for a total of $27,000 plus interest over four years. This leaves many students and parents in need of more.
Parents can also borrow federal loans, and parents can borrow up to the full cost of attendance; however, Parent PLUS loans, the federal loan available to parents, will have a whopping 9.08% interest rate, plus a 4.228% origination fee. That's pretty bad, and what's worse is that parents are the fastest-growing segment of student loan debtors, with many carrying student loan debt into retirement.
Normally I advocate that families should start with the federal loan programs. However, because of the high rates and how interest rates are determined for federal loans, this year it could make sense to shop around. Before you start shopping, though, there are some parents who should stick with the federal programs despite the high rates:
Parents who are eligible for Public Service Loan Forgiveness. If a parent works in the public or nonprofit sector and will continue working for at least 10 years following the student's college graduation, they could be eligible for public service loan forgiveness and should stick with federal loans.
Older parents, especially those with lower incomes, who could be eligible for income-based repayment and are unlikely to outlive the student's loan. Federal student loans are non-recourse, meaning that if you are unable to repay your loans due to death or disability, that debt will not be assigned to anyone else such as your spouse or other heirs.
Many private lenders offer better rates than this year's Parent PLUS loan rates, so it could be worth shopping around. Sites like Credible.com allow you to comparison shop among lenders to find the rates and terms that work best for you. Families looking at private loans should consider several factors:
Is the interest rate fixed or variable?
Does the loan have other fees besides the interest? These might include origination fees, application fees, fees to remove a co-signer, and more.
What payment term is being quoted? Loans quoted with longer payment terms will have smaller monthly payments; however, you'll pay more over the course of repaying the loan.
Is your credit rating high enough to get the best rates?
How easy or difficult will it be to remove the parent as co-signer in the future?
Does the lender operate in your state?
Parents often wonder who should borrow a student loan. Even if you intend to pay off the loans, your student should take out the direct student loan. It has the lowest interest rate and all the borrower protections of the federal loan programs. For parents who are borrowing, it depends on the parents. If parents could be eligible for loan forgiveness, it's important to have the eligible parent borrow. That usually means the public service employee, the lower earning spouse, or the older spouse. With private loans, it can vary by lender so it can make sense to review the terms to see if one would be more favorable than the other.
Student loans are disbursed to the college first. Once the college has deducted tuition, fees and any other costs such as direct-billed room and board, the balance is disbursed to the student. This brings up two important points:
Now is a great time to review your financial aid package to see if loans are already included. It's not terribly uncommon for parents to discover after graduation that they took out Parent PLUS loans, because they didn't realize that the large number in their financial aid package was a loan and they never saw the money. You are not required to accept loans that are included in your aid package, so make sure to waive them if you do not want them.
If you are using loans to pay for things like room and board, there will be a delay between the loan being disbursed and you receiving the funds as the college settles your account. If you need to pay rent before the third week of the semester or quarter, you might need to pay for it somehow other than a student loan.
How do you apply for a student loan? The FAFSA is the application for federal student loans including the Direct Student Loan and Parent PLUS loan. If no loan was included in your aid package, simply reach out to financial aid to request it. Divorced parents where the borrowing parent is not the parent who filed the FAFSA should contact the school's financial aid office directly to request a Parent PLUS loan. For private loans, you apply through the lender.
There are other loans available to pay for college besides student loans. One loan you should never use for college: a 401k loan. Those loans have to be fully repaid within 5 years, max out at $50,000, and have to be repaid in full within 60 days of leaving a job should you resign or be terminated.
Did you find this helpful? If so, grab a copy of my book, How to Pay for College. This week it’s just $7.99 on Amazon!
