Let’s Look at Student Loans: Federal vs. Private

Jill and I are excited to see our oldest daughter Maeve preparing to graduate high school this spring and move on to college in the fall to study nursing. While we are all very proud of her, it does not remove the fact that for years I have been telling our three girls the moment we move them into college, we are going to renovate their old bedrooms and rent them out on AirBNB or Vacationrental.com.

They don’t believe me.

Seriously though, as parents, Jill and I feel so rewarded to watch Maeve make the transition from childhood to a world of adulthood, scholarship and achievement. It’s also gut-wrenching, heartbreaking, and occasionally terrifying. We’re seeing the same process occur in the households of our friends, clients, coworkers, and colleagues too, so we know we’re not alone.

Specifically, I can’t think of a much more stress-inducing topic than the cost of higher education, bth for parents and college students to be alike. We all know, either from our own direct experience as student loan borrowers or from what we’ve read and seen on the news, that student loan debt is creating a bigger and bigger burden across the country. In fact, 69% of the Class of 2018 took out student loans, with the average debt at $29,800, according to Student Loan Hero. There’s about $1.56 trillion in total U.S. student loan debt.

Annual education costs continue to climb. Tuition and fees rose 3.1% last year at four-year public institutions, to $9,970, according to the College Board. Higher still for four-year private institutions, up 3.6% last year to $34,740.

You see, many of our kids enter their adult lives already shouldered with higher education debt. And outside of buying a house, student loan debt is the most debt many people carry through their adulthood. To put this into a bit of a different perspective, there’s currently $1.56 trillion in outstanding student loan debt. According to the Federal Reserve, consumer credit card debt recently topped $1.04 trillion. Student debt may only get deeper and deeper if these kids pursue graduate degree work and other academic distinction that so many professions require.

So, it’s little wonder that parents also shoulder a lot of their own debt to pay for their children’s education. According to the College Board, 14% of the parents of the Class of 2018 took out an average of $35,600 in Parent PLUS federal loans.

I reached out to Raquel Nejako, President of New England College Planners in Mashpee, for her insight. Raquel is an expert in helping kids find the right school, and more importantly, where to get the money to pay for it. Raquel says, “Paying for college actually begins long before the financial aid process, to the surprise of many parents. It starts with an academically and financially balanced college application list—something that is really rather rare. Too often students are left to their own devices to put together a list of potential colleges with no understanding of what those schools might have to offer financially. Sometimes I find that academically strong students (and their parents) have caught “Ivy fever”, loading their list with top-tier schools without realizing that these universities do not offer merit aid. This could cost a family of modest means dearly in the financial aid process.

Great advice Raquel!

Any good parent wants to give their kids every advantage, right? For many families, paying for a child’s higher education starts with savings and investments made on their behalf by parents, grandparents and other family members. Scholarships, grants, and work-study programs can also go a long way to help mitigate the burden of college debt. We and the appropriate resources, as Raquel suggests, can help guide them through the labyrinth of financial aid to find any support that can help. It all adds up, but even then, many students and their families need loans to fill in the gap.

It’s crucial to help your student differentiate the types of loans available to them. This can only help them to manage their debt much more effectively when it comes time to leave the academic world for the professional world in which they’ll spend the rest of their lives. Help them understand that decisions they make about how to pay for their future will have a profound effect on that future.

The financial aid process often begins with the FAFSA, the Free Application for Federal Student Aid. Uncle Sam requires families to fill out the FASFA to qualify for federal student loans issued through the U.S. Department of Education.

Federal loans must be paid back with interest, but not until after the student leaves college or drops enrollment below half-time. Interest rates are fixed, set by law, and usually significantly lower than private loans. The federal student loan program provides four types of Direct Loans.

The first type is the Direct Subsidized Loan, for those students who demonstrate financial need. The second type is the Direct Unsubsidized Loans, made to eligible students not based on financial need. Next is the Direct PLUS Loan, made to graduates and parents of dependent undergraduates to help pay for educational expenses not covered by other financial aid. Finally, Direct Consolidation Loans combine eligible federal student loans into a single loan with a single loan servicer.

Undergraduate students are limited to borrowing $5,500 – $12,500 per year in Direct Subsidized and Direct Unsubsidized Loans. The amount depends on what year the student is in school and the student’s dependency status. That can leave gaps between the student’s actual resources and the tuition bill.

This is where private student loans may help fill that gap. Many private lenders don’t require a FAFSA form to qualify for a private loan. However, they do impose credit checks, income verifications, and other qualifications before they’ll write a check. Borrowing options can be more flexible since private student loans aren’t based on need. The creditworthiness of the lender and their cosigner, if necessary, can even work to their advantage to qualify for lower rates. Private lenders may also offer variable rates. While a variable loan may provide a lower interest rate at first, a bit of caution should be exercised here with rates potentially on the rise.

Raquel adds, “It bears saying that though they are marketed as private “student” loans, these loans must be cosigned by a parent and are, as such, really just a loan in the parent’s name. Rates for these loans are affected by parent credit scores. Some of these private loans are better than others: look for those with fixed rates and the option for the cosigner to come off the loan after the student has made good on payments for the first three years (these loans are typically amortized over ten to fifteen years). A parent may want to explore options which allow for a lower interest rate, such as borrowing from themselves with an equity line of credit.

Great insight Raquel!

As you know, a parent’s work is never done. Even after our kids are off in the world, we’ll still worry. But for now, we can simply help guide them in the right direction to give them the best chance for a successful and happy life. Helping our future graduates make the most appropriate borrowing choices for their higher education costs is just another part of that process.

Be vigilant and stay alert, because you and your family deserve more.

Have a great week!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@cutterfinancialgroup.com.

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