If you’ve been following the news about interest rates on student loans, you know it recently doubled from 3.4 % to 6.8%. Our Congress spent the past month debating this issue and has now passed a bill that’s both good news and bad news – depending on several factors
If you’re an undergraduate
If you or one of your children is currently an undergraduate, he or she will be able to get a subsidized Stafford loan at 3.9% this fall, which is certainly much better than 6.8%. Graduate students will be able to get loans at 5.4%, which is higher than undergrads but still more than a point lower than the 6.8%. And this is the good news.
The not-so-good news
If you or your child gets a student loan this year, his or her interest rate will be locked in for the year. However, in the future interest rates will be tied to the financial markets. The way this works is that there will be a formula based on the interest rate on 10-year Treasury notes so that student loan interest rates will vary as those interest rates change. But they will top out at 8.25% for undergraduates and 10.5% for graduate students.
Each year could be more expensive
The way this nets out is that student loan interest rates are likely to become more expensive in the coming years as our economy continues to improve. So the 3.9% interest you or your child is paying this year could go to 4% or higher next year.
Who’s affected
While there has been much discussion and politicking over these interest rates the fact is that only one type of student loan is affected – direct, federally subsidized student loans (also called DLP, FDSLP, and Direct Loan Program)
This is a very specific type of loan where the government pays the interest on the loan while the borrower is still in school, during a six-month grace period after he or she leaves school and if the loan goes into deferment (where the borrower needs to defer his or her payments).
Only new loans
If you or your child already has one of these student loans, fear not. The new interest rates affect only new loans that are disbursed after July 1 of this year. If you or your child has a loan that was disbursed prior to this, neither your interest rate or your monthly payments will be affected. Other federal loans such as PLUS loans and Perkins loans are also not affected by this change in interest rates.
After July 1
If you or your child takes out a loan after July 1, you won’t have to take any immediate steps. This is because your payments won’t be affected until you graduate or drop down into part-time student status. As an example of how this would work, if your child is a freshman and you took out a Stafford loan, it won’t be until 2018 that the 6.8% interest rate kicks in and after your grace period has expired. In the event that you need to get a loan deferment, the new interest rate might not kick in until even later.
If you don’t have a direct federally subsidized loan
Of course, if you have a non-federal loan from a bank or some other private source, this interest rate change will have no affect on you. Your terms will remain the same for the life of the loan so long as you have a fixed rate loan.
Be sensible
The important thing about borrowing to finance your education is to be sensible. Today’s college students are graduating with an average of $30,000 in student loan debt. And they’re not finding jobs. In fact, nearly half of those who graduated in 2012 are still either looking for work or are working in jobs unrelated to their fields of study. Before you or your child starts borrowing money, you might think in terms that you’re making an investment and check out its ROI. In other words, your child might want to major in social science, philosophy or history but will he or she ever be able to get a job in that field? And if so, what will it pay? When you consider these factors, you might decide to either encourage your child to choose another major or to enroll in a cheaper school. For instance, what many parents are doing today is having their child go to a community college for the first two years, get their core, requisite courses out-of-the-way and then transfer to a four-year school. This could at least chop that $30,000 down to maybe less than $20,000 in student loan debt.
Other alternatives
Another thing to keep in mind before rushing off to sign up for a federally subsidized loan is that there are alternative ways to finance a college education and here are some of them.
Search for select scholarships – one of the best ways to win a scholarship is to find one offered by an organization, club or professional group. There is usually less competition for this type of scholarship as there are fewer people who apply for them.
Enlist help from relatives – grandparents can make gifts to 529 accounts without the same type of restrictions that exist on other kinds of financial gifts. In fact, they could gift up to $13,000 a year per child to a 529 plan and not pay any gift tax.
Reconsider public service – if you or your child were to go to work in the public service sector, he or she would be required to make payments on the loan for 10 years but the rest of the loan would then be forgiven..
Find the right schools – there are schools that are actually tuition free such as the Cooper Union for the Advancement of Science and Art and the Franklin W. Olin College of Engineering. There are also seven “work” colleges in the U.S. where students can exchange work for reduced tuition. Plus, there are “no loan” schools that advertise they can handle your child’s financial needs through scholarships, grants, and work-study jobs.
Prioritize payments – to get the maximum amount of federal aid, your parents might want to stash money in places that are not part of the Free Application for Federal Student Aid
Save in the right name – it may be better to put any savings to be used for college in the parent’s name rather than the student’s name where it could be assessed at the rate of 20%.
Maximize your income – There are numerous programs that can help borrowers with low incomes get through school. For example, if the parents have an adjusted gross income of $50,000 or less and who live in a household where everyone is eligible to fill out an IRS form 1040A or 1040EZ, you could apply for what’s called a streamlined needs test. This will remove certain assets from the formula for federal needs to make your child more eligible for aid.
Watch this video
Finally, here is a video with more information on how to sensibly finance a college education.