Navigating the Student Loan Maze

Question of the week:My high school age son is starting to think about college, and I'm starting to get nervous about paying for it. Can you provide some guidance on student loans? --Andrew G.

Dear Andrew,

Given the high cost of college these days, your worry is quite understandable. According to Nellie Mae, one of the leading national providers of college loans, the average undergraduate student loan debt today is $18,900.

But the news really may not be all bad. When we asked members of the Armchair Millionaire community recently about how they are handling their student loans, many told us how they are making lemonade from lemons. This story was typical:

"My parents helped me as much as they could to pay for college, but I still have a lot of loans. Recently, I consolidated my loans to lock in a fixed rate of less than 4 percent interest and a slightly longer term. I intend to pay off the minimum through an automatic debit system (which also lowers my rate) and invest extra money I would put toward the loans in a Roth IRA." --Jason

Before you (and your son) plunge into debt for college, you should have a very clear understanding of your student loan options. My guide provides the basics on the most common choices.

The Armchair Millionaire Guide to College Loans

• Stafford student loans. These are federal loans with low interest rates, extended and flexible repayment terms, and that do not require collateral. They also offer options for deferment. The loans may be made either from a private source, like your bank, credit union, or savings and loan (in this case, the loan is guaranteed by the government), or else directly from the federal government. The interest rate is variable, but capped at 8.25 percent. For the 2002-2003 school year, the interest rate is 4.06 percent. There are two different kinds of Stafford loans:
  • Subsidized. The government pays the interest on the loan while the student is in school, and repayment does not start until six months after graduation or leaving school. These loans are need-based.
  • Unsubsidized. The student is responsible for the interest during school, although he or she can defer the payments until after college. These loans are not need-based, so anyone, regardless of income, is eligible.
  Undergrads who are dependents can borrow up to $2,625 their freshman year, $3,500 their sophomore year, and $5,500 for each of the final two years. Some students end up with a combination of both subsidized and unsubsidized loans to make up the maximum.

• Parent Loans for Undergraduate Students (PLUS). As you can guess from the name, these are for mom and dad. Like the Stafford, the PLUS is a federal loan, and is available either from private lenders or directly from the federal government.

  The PLUS has a much higher limit than the Stafford--up to the entire cost of the child's education, minus other financial aid. Interest rates are variable, but capped at 9 percent, with repayment starting 60 days from the time the loan is given. For the current school year, the interest rate on PLUS loans is 4.86 percent. Unlike the Stafford, PLUS loans are in the name of the parents, and are their responsibility.

• Private loans. If you need still more borrowing choices, you can turn to a private loan from a bank. Your bank may offer a lower interest rate or other favorable options when the money will be used for education than for regular consumer loans. Parents are generally the borrowers, although the student can apply, too (assuming that he or she is credit worthy.) The terms for these loans will vary considerably from one lender to the next, so compare several to find the best interest rate and most convenient repayment arrangements.

THE BOTTOM LINE: Sending a child to college without incurring debt is simply not an option for many parents. But by choosing your loans wisely, you can minimize the pain.

Comments

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