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This is an article in an occasional series on personal finance. Each article will address a different aspect of personal finances and provide some tips for you. However, always consult your own financial adviser or tax professional for your specific situation.
Driving around, I see all of the houses with balloons tied to mailboxes signifying a high school graduate. And I see the tents, tables and chairs set up underneath for the big graduation party. It’s an exciting time for families and friends.
It’s also a time for a range of emotions from excitement for the next chapter of life, to worrying about how much you’ll miss your “baby boy” or “little angel.” Before we get too far ahead, there is the little matter of figuring out how to pay the tuition bill that will be arriving soon.
Even for families that have few resources, there are a number of options, including loans, tuition payment plans, and getting outside scholarships. What causes the most confusion, however, is loans. Which one is right for your family depends on your situation, but understanding the differences is the first step.
First and foremost, your student can borrow directly from the federal government through the Direct loan program. They are the borrower; no co-signer needed. The amount your student can borrow each year is as follows:
Freshman year – $5,500
Sophomore – $6,500
Junior – $7,500
Senior – $7,500
And then if your student goes another semester, for example, he can borrow another $4K for a total program maximum of $31K.
The interest rate is fixed at time of loan disbursement and set for the life of the loan. No payments are required while the student is in school at least part time. And up to $3,500 each year could be subsidized, meaning that interest does not accrue while she is in school, but the unsubsidized version accrues interest.
If additional borrowing is needed, parents have a number of choices, but it also raises a number of philosophical questions. And rate is only one of many factors.
One question is who will be the borrower. The parents can borrow, or the parents can co-sign with the student. If the parents want to borrow themselves, they can use either private loans or the Parent Loan for Undergraduate Students program from the federal government.
On the other hand, if parents want to co-borrow with their student, then private loans are the way to go. Some private loans do offer the possibility of co-signer release, and each lender will have their own terms and qualifications for doing so. PLUS loans, since the parents are the only borrowers, have no such provision.
By the way, a question that I often get is whether or not students, later, can get a loan to pay off the PLUS loan. The answer – some lenders allow, others don’t. The opposite though is certain – you cannot use a PLUS loan to pay off a private loan.
Keep in mind that with any private lenders, the borrower – either you or together with your student – will need a good credit score and enough income to handle the loan payments.
The availability of repayment plans also needs to be considered. Private lenders will offer a number of repayment options, though loan terms tend not to last beyond 15 years. PLUS loans can offer repayment terms up to 25 years to lower your monthly payment at the cost of higher total interest paid over the life of the loan.
One important difference in repayment plans between private versus the PLUS loan is the availability of income-based repayment. That is, the repayment amount can be based on your income rather than on the loan term for a PLUS loan.
And lastly, there are differences in the rate. Private loans offer the choice of fixed or variable rate, with the variable possibly being much lower than the PLUS loan rate. The PLUS only offers a fixed rate.
Separately from student loans, some families may borrow against their home equity or even use a 401k loan. With all of these choices, what is true is that how you pay the college bill is not a mutually exclusive decision. Parents can choose multiple options, or even use different options at different times, such as starting out with a PLUS loan and then refinancing onto their house.