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Amy Goan, MBA, CFP®
Email: amy@prismfinancialplanning.com
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How to Pay for Junior’s College (Part 2): Loans

Loans for When You Need to Borrow Money for College

Last week I wrote about the different saving and investment vehicles available for parents who want to save for their child’s college. In a perfect world you would have saved enough money to pay for your child’s college education by the time she has graduated from high school. Unfortunately, we don’t live in a perfect world and you may be placed in the situation where you need to borrow money in order to pay for college. If this is the case for you, you have many different options.

college loan

Federal Stafford Loans are loans made by the government to both undergraduate and graduate students. They charge lower interest rates than private loans, but come with some restrictions. The interest rate charged is fixed (currently 3.86 for undergraduates) and has a 1.0% origination fee. These loans can be either subsidized or unsubsidized, depending on financial need. There are different loan limits ($23k-$73.5k) as well as when the interest charged begins to accrue, for each loan type. For subsidized loans the federal government "subsidizes" (or pays) the loan interest while the student is still enrolled in school. The interest owed on a Stafford Loan is tax-deductible, although with everything regarding taxes, there are certain restrictions. To apply for a Stafford loan, you must complete the Free Application for Federal Student Aid (FAFSA) at FAFSA.ed.gov.

Another federal loan program is the Federal Perkins Loan Program, which are low interest loans made directly from the school to needy students. Unfortunately, not all schools participate so you’ll have to check with the financial aid office of your school of choice to confirm its availability. The current interest rate charged on these loans is 5% with no no origination fee, and the undergraduate limit is $27.5k. These loans must be paid back within 10 years, and repayment will begin 9 months after leaving school. Like the subsidized Stafford Loan, interest does not begin to accrue until the borrower is no longer in school. Also like the Stafford Loan, the Perkins Loan interest owed is tax-deductible with the same restrictions. To apply for a Perkins Loan, you must also complete the FAFSA.

Direct PLUS Loans are loans made by the Department of Education to parents of college students, or directly to the students themselves. Unlike Stafford and Perkins loans, these loans are granted based on need and credit history. Only certain schools participate in the Direct PLUS Loans. The interest rate for Direct PLUS Loans is a fixed rate of 6.41%, in addition to a hefty 4.204% loan origination fee. Interest accrues while the student is in school, but repayment doesn’t begin until up to six months after the student is no longer in school. For most borrowers the interest is tax-deductible, but for higher earners it may not be. To apply for a Direct PLUS Loan, you must also complete the FAFSA.

There is one important fact to consider when you’re deciding whether to take out a federal loan: Unlike credit card debt and mortgages, which can be canceled if you file for bankruptcy, education loans of all types must be paid. Most bankruptcy courts will not cancel them unless your situation is extremely dire.

Private Loans may cost more than loans offered by the government or schools, but charge less than credit card debt. Interest may not be tax-deductible.

Home Equity Loans (or Home Equity Lines of Credit) can be used to fund college, and its proceeds won’t count as an asset for financial aid calculations. However, there is no tax deduction on the interest charged. I’m going to ask you, as I did in How to Pay for Junior’s College (Part 1), to please repeat after me: I promise to never fund my child’s education using the money I’ve saved for my own retirement. That includes taking out a loan or getting a second mortgage to pay for your child’s education if it jeopardizes your ability to fund your retirement. As I said in Part 1, your child can borrow money for school and have the rest of her life to pay off that debt, but no one will lend you money to pay for your retirement.

Come back next week for How to Pay for Junior’s College (Part 3): Grants and Scholarships

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