Monthly Archives: May 2014

Whose Loan Is It Anyway?

Regardless of who is going to be paying back the loan, it’s worth looking at both parent and student loans when you consider borrowing for college. Each has its pros and cons and depending on your situation, one may be better than the other.

In general, interest paid on student loan debt—federal or private loans—is tax-deductible to the named borrower, so long as the borrower’s income falls below certain levels and the borrower is not claimed as a dependent on anyone else’s tax return. In 2014, the deduction phases out between $60,000 and $75,000 for single borrowers and $125,000 and $155,000 for married filing joint. If the parents’ income exceeds the applicable cap, then they cannot claim a tax deduction for the interest. It’s more likely that the student’s income will not exceed the cap, so even if the parent is paying off the loan, it can be beneficial to have the student be the named borrower. Again, the interest is deductible to the named borrower, regardless of who makes the payments.

As discussed previously, Stafford loans (loans to students) have lower interest rates and fees, but also lower limits on the amount that can be borrowed. However, for most families intending to borrow, they can be the best starting point.

PLUS loans have higher limits but are only made to parents or to graduate students, and the interest rates and fees are higher. But the parent can take the tax deduction for interest paid if their income falls within the applicable range.

For better or for worse, there are many borrowing options available to college students and their families. Who takes out the loan is just one of the questions to answer.

Key Findings About Student Debt

According to a recent report from the Pew Research Center, “Student debt is the only kind of household debt that continued to rise through the Great Recession, eclipsing credit card debt to become the second largest type of debt owed by American households, after mortgages. According to a new Pew Research report, a record 37% of young households had outstanding student loans in 2010, up from 22% in 2001 and 16% in 1989. The median student debt owed by these young households was $13,000.”

Click here for the full report.  

“Is It Still Worth Going to College?”

Fed economists Mary Daly and Leila Bengali explore this question in a new research paper. Their conclusion? Based on lifetime earnings, yes: “for the average student, tuition costs for the majority of college education opportunities in the United States can be recouped by age 40, after which college graduates continue to earn a return on their investment in the form of higher lifetime wages.”

They note several important caveats:

  • The “breakeven” tuition rate, i.e. the cost at which the typical college graduate will recoup the cost of college in 20 years through increased earnings is $21,200.
  • Although many colleges cost more than that breakeven rate, “there is no definitive evidence that they produce far superior results for all students.”

The paper includes a tuition calculator that allows you to enter your own data and scenarios. Read the entire paper and access the calculator here.

Federal Student Loans

The most common federal student loans are Stafford and PLUS loans. The biggest distinction between the two is that, for undergraduates, Stafford loans are loans made to students and PLUS loans are loans made to parents. Regardless of who’s going to be repaying the loan, it’s worth looking at both to determine which is a better deal.

With a Stafford loan, the student is the borrower. Stafford loans have an annual loan limit depending on the student’s year in school and whether or not they are independent. A dependent freshman can borrow $5,500. That amount increases to $7,500 by the third undergraduate year. Stafford loans have a fixed 3.86% interest rate and a 1.072% loan fee. Because most 18-year-olds have minimal credit history, credit ratings are not considered in the Stafford loan process. Students with financial need may receive a portion of their loan Subsidized, which means that no interest accrues until graduation.

A PLUS loan is taken out by the parent. It has advantages and disadvantages compared with a Stafford loan. You can borrow substantially more with a PLUS loan than a Stafford loan: up to the full cost of attendance at your school, minus any aid received. In exchange for that, though, you’ll pay a higher interest rate (6.41%, fixed) and loan fee (4.288%). And because larger sums are involved, credit worthiness is verified.

Stafford loans tend to be the best starting point for most families, regardless of who will be repaying the loan. Why? Because of the much lower interest rate and fees. In addition, student loan interest is tax deductible, but only to the named borrower and only within income limits (the deduction phases out between $60,000-$75,000 for single filers and $125,000-$155,000 for married filing joint). Many parents are not eligible for the deduction, but most recent college graduates are. If you aren’t eligible, think of the tax deduction as a gift to your college student or graduate—it may be worth several hundred dollars a year to them. Which is about the same amount as a monthly payment on four years of Stafford loans consolidated.

Choosing a Loan

For many families, it’s crunch time: your student has accepted admission at a college and now you have to figure out how to pay for it. Most families borrow some or all of the cost of college. There are tons of ways to borrow, and you can always find someone willing to loan you money for college. The key is to do it the right way.

Student loans fall into two big buckets: federal loans and private loans. Federal loans include Stafford and PLUS loans. Private loans are available from a myriad of lenders including Sallie Mae.

Federal loans are generally better than private loans for a variety of reasons: fixed interest rates, students can borrow without a co-signer, and they have various repayment options that make them less onerous: income-based payment plans, forbearance options, consolidation and more.

While there are some good lenders in the private loan space, there are also many who market through misinformation. Typical tactics include low teaser interest rates which then go up as high as 11% and quoting longer repayment terms in order to quote monthly payments lower than does a Stafford loan. Rarely is a private student loan a better deal than a federal loan if you do an apples-to-apples comparison.

The key points to consider when comparing loans are these:

  • Interest rate for the life of the loan. Keep in mind that interest rates are very low right now. It’s highly unlikely that the rate on an adjustable rate loan will go down over the term of the loan.
  • Repayment term and options to extend it. For example, the standard repayment term for a Stafford Loan is 10 years, but with consolidation and forbearance options, you may be able to extend it to 25 years. Remember that a shorter term will mean a higher monthly payment, whereas a longer term will mean that you pay more in interest over the life of the loan.
  • Monthly payment. Stafford Loans have a minimum $50 per month payment with standard repayment terms. When comparing monthly payments, it’s important to consider the term of the loan to determine if you’re really saving money when the quoted payment is lower. (Hint: the loan is cheaper if the interest rate is lower.)
  • Hardship options. Federal loans have income-based repayment options, and are discharged in the event of death or disability.
  • Loan fees. Stafford Loans have a 1.072% loan fee. PLUS loans have a 4.288% loan fee. Private loan fees vary by lender and loan.
  • Who is taking out the loan? Students and parents can borrow. There are pros and cons to each, regardless of who will actually be making the payments. I’ll discuss that in a future post.