Using loans to pay for college can work well or be a nightmare. Those who know the facts, plan ahead and borrow as little as possible — and responsibly — don’t often run in to problems. You can be in that boat.
MyCollegeCorner.Org recently released two free webinars featuring plain-English, easy to understand explanations of how student and parent loan programs can work best for your family:
- The Good, the Bad and the Ugly of Student Loans
- Parent PLUS vs Private Credit Parent Loans – An Essential Guide
I also interviewed Ombudsman and Director of Consumer Advocacy Kevin Fudge, who discussed the role of Ombudsman and offered wonderful tips for student and parent loan borrowers. That Podcast can be found here.
Here’s a quick summary of those webinars and interviews so you can make student and parent loans work for you. The first required bit of knowledge: there are separate programs for student and parent borrowers.
Federal Direct Student Loans
As the name implies, these loans are made by the federal government directly to students. Here’s what parents need to know about federal direct student loans:
- Students become eligible for federal loans after they file the FAFSA (Free Application for Federal Student Aid) form.
- Student loans are often included as part of a Student’s Financial Aid Award letter.But, loans are not free “aid,” they must be repaid. Also, students are not required to take the loan.
- All undergraduate students, regardless of family income are eligible for some form of government loan. Students from lower income families may receive Subsidized loans, which means the government pays the interest while the student is in-school and immediately after. Other students receive Unsubsidized loans and are advised to pay the interest while in-school otherwise those amounts are added to the principal amount of the loans.. Still others receive a combination of Subsidized and Unsubsidized loans.
- The maximum amount a dependent student is eligible for is $5,500, $6,500 and $7,500 for first, second, and third/fourth year students respectively.
- Loan repayment plans are very flexible under the Federal Direct Loan Program with many plans based on the student’s income. Students should contact their student loan servicer to determine the best plan for them. They may also switch from one plan to another as they are repaying their loan.
- A student signs a Master Promissory Note (MPN) at the time of the first borrowing, has an entrance counseling session and is required to file a FAFSA form for each subsequent year that they need federal aid. This means that a student can end up with up to $31,000 of student loan debt after giving one electronic signature on an MPN. YIKES!!!
There are two primary loan programs for parents of undergraduate students: The Federal Government’s PLUS (Parent Loan for Undergraduate Students) and Private Credit Student Loans. I’m not a fan of using Home Equity Loans or dipping into retirement plans such as 401K plans to pay for college so I’m excluding them here.
The Federal PLUS program
Ugh. I have so many problems with this program. The root problem is that is a political solution for those trying to ensure access to college. It is not a well thought out solution for parents who need to borrow smartly and affordable for their children’s college education. Frankly, if the PLUS Loan Program was set-up by private lenders and not the Congress, it would likely have been shut down long ago.
But let’s start by being positive. Here’s what I like about the Federal PLUS Loan program:
- The lender is the federal government, so it can offer repayment options that are far more flexible than private lenders’ repayment requirements.
- If a parent happened to be credit denied for a Parent PLUS loan, their undergraduate dependent student may be eligible for an additional unsubsidized loan up to $4,000 during their first or second college year or up to $5,000 during their third or fourth college year. The aggregate limit of $31,000 still applies.
That’s all I like about it. Really.
Here’s why I’m not a fan and parents should be wary of the PLUS program:
- Minimal credit test: you can get a loan as long as they don’t have “Adverse Credit” – a very low barrier.
- High borrowing maximums: you can borrow up to the full cost of attendance less financial aid. It can be a lot if your child doesn’t get a hefty financial aid package and is going to a high-cost college. And don’t forget to multiply the first-year borrowing amount by four to account for each year it will take to get your son or daughter to graduation.
- High fees: If you borrow $10,000, you have to pay almost $500 in origination fees to get the loan so the amount you receive will be closer to $9,500 — but you have to pay back $10,000 with interest.
The biggest issue for me is the minimal credit test. Too many well-intentioned parents with the dream of college for their families get a loan that they have little chance of repaying. Private lenders, unlike the federal government, test to see if a borrower has the income and capacity to repay the loan BEFORE it is made. Not so for the federal government. PLUS Loans are made without any regard for the borrower’s income or capacity to repay. That is fundamentally wrong.
Of course, the PLUS Loan program works well for some families. I’m just saying: buyer beware. Know before you owe. Borrow smartly. And do not endanger your retirement.
Private Credit Loans
Private credit loans are made by banks, credit unions, states and state-related agencies, credit card companies, specialty finance companies and others. Some colleges also make private credit loans too.
In most private credit loan programs, the borrower is the student who enlists the support of a cosigner. When making their decision to lend or not, the lender considers the credit profile of both the student and the co-signer, often a parent. I co-signed a loan for my daughter. Every month, we each get a bill from the student loan servicer. If she misses a payment, the loan servicer would expect me to pay.
Private lenders use credit tests similar to financing a car or home when deciding to make a parent loan. In addition to providing information about your income, you will authorize the lender to “pull your credit” from one of the credit bureaus that tracks your payment history and assigns you a score. The FICO score is one such input often used by the lender in their credit decision.
Here’s what I like about private credit loan programs:
- Not everyone qualifies to receive a private credit loan. This may sound bad, but it’s better to not receive a loan you can’t afford to repay than receive a loan that will cause you huge amounts of stress in the future.
- The interest rate you pay is based on your credit history. Those with stronger credit pay less than those with weaker credit histories.
- For most programs there aren’t any origination fees. Borrow $10,000 and receive $10,000.
- Borrowers may select the type of interest rate they prefer (a fixed or variable rate).
- Some lenders have discounts for good students or making electronic payments.
- Many programs offer a cosigner release, so parents can lend their good credit history to a student and then be released from the debt once the student gets on their financial feet.
Here’s what I don’t like about private credit loan programs:
- The repayment terms are relatively inflexible. The lender expects to be repaid based on the terms of the original loan – even if you’re circumstances change.
- There are many programs with many options. Choosing one can feel overwhelming.
Choosing among parent loan programs
Start by using the PLUS Loan program as a basis of comparison. Information about the program including current the interest rate and fees is easily found at https://studentaid.ed.gov/sa/types/loans/plus. Those with strong credit should be able to find lower rates and more favorable terms from private lenders. Just be careful that the repayment terms are comfortable.
Shop around among the various types of private lenders. Check local banks and credit unions, your state agency that offers parent loans and others, so you may compare:
- Interest rates: variable or fixed, and how high?
- Repayment terms
- Cosigner releases
- Lender reputation or a relationship you might value
One last caution: before taking the first loan, be aware of (1) the total amount of debt that might be required for each year of college and (2) the potential for having to support more than one child.
Ok – let’s say you’ve done all of this. You shopped. You borrowed wisely but there is still a problem. You or your student are unable to make the payments. Here’s what to do:
- Contact your student loan servicer sooner, rather than later
- If you are at an impasse and feel that you have been unjustly treated, contact an Ombudsman. Kevin Fudge is the Ombudsman at American Student Assistance in Boston. There are Ombudsman across the country. Learn more about them and to get some great tips from Kevin in our podcast at MyCollegeCorner.Org. Click here to link to get the benefit of his experience.
In conclusion, student and parent loans work well for the majority of families, but there are still too many that get into trouble by taking excess debt for the outcome achieved. Planning ahead and being realistic about your capacity to repay debt may be two most important things you can do to help your children achieve their dream of college without turning the experience into a nightmare of unaffordable debt.
The last word and a key to smart borrowing and minimizing college debt: Saving a dollar today is better than borrowing one tomorrow.
Please let me know what you think. Join the My College Corner Families group on Facebook or contact me directly at John@Inviteeducation.com