How to Pay for College with Loans – Being a Smart Borrower
By Joe Messinger, CFP®
January 20, 2023
Families often wonder how to pay for college with loans. It’s tough to know how to make smart decisions that will positively impact your future and your child’s.
As of the end of 2022, Americans owe $1.745 trillion in student loan debt with 42.8 million borrowers (of federal loans). Those are some staggering numbers!
For most college-bound families, student loans are part of the picture when paying for college. Nearly 7 in 10 students graduate with some form of student loan debt. The reality is the cost is just too high. In other words, they have a gap, and loans may be the only way to fill it.
What do you need to be aware of?
First, know the total cost for all four years down to the penny. You can’t plan without seeing the whole picture. With the total amount calculated, consider if your assets, scholarships, grants, cash flow, and tax credits can cover that number. If not, you have a gap.
Federal vs. Private Loans
So, how do you bridge that gap? Federal loans must be your first stop when filling your funding gap.
We refer to federal loans as “use it or lose it” loans. Loan amounts are capped yearly, so don’t wait to take advantage of them. Our blog has a great explanation and graphic of what we mean.
We like to suggest that private loans are the last option for families. Families run into trouble later when they take excessive private loans.
Finally, federal student loans offer repayment and forgiveness plans that private lenders may not offer. Federal loan forgiveness for teachers, public service, etc., is sometimes talked about for private loans, but we doubt it will ever happen. Repayment plans, a benefit of federal loans, let you make payments based on your income.
Private loans rely on the credit record of the co-signer. Interest rates will vary based on their credit rating. Students have no track record of handling debt, and their ability to pay is unknown to the bank, so a co-signer is critical.
Parents with bankruptcies or other past credit problems will have difficulty getting a loan. Even Parent PLUS loans are subject to creditworthiness considerations.
Are loans transferable to others?
Parents mistakenly believe that Parent PLUS loans in their names can be transferred to their students after graduation. Parents cannot transfer their PLUS loans. Mom and dad continue to be responsible for that loan themselves after their student has graduated.
Similarly, co-signer parents or grandparents on private loans will remain on those loans until their graduate establishes good credit later in their work experience.
On the flip side, federal loans (non-PLUS) are issued in the student’s name. They help your student build a good credit record.
The federal loan (incl. PLUS) is discharged if the student passes away. On the other hand, private loans typically remain the co-signer’s responsibility. Remember to read the fine print!
Knowing the downsides, how do you get a private loan?
The first step is always to contact the financial aid office of the college your student is planning to attend. They may have a list of preferred lenders to recommend. Take these recommendations with a grain of salt. They may not always be the best option for the consumer, but they are an excellent place to start. The lender is up to you. You do not need to stick with the college’s list.
Compare products when making your choice!
Consider the following variables when deciding on a lender:
- Interest rates (fixed vs. variable)
- The total cost of the loan
- Fees (including origination)
- Repayment terms (if available)
- Credit requirements
- Academic progress requirements
- Lender reputation
- Customer service
Home sweet home?
If parents are looking at ways to finance college, they may want to consider a home equity line of credit–only after federal direct student loans! If you have good credit and equity in your home, this strategy may offer a better interest rate, and typically the interest is tax deductible.
Proceed with caution, though. Being mortgage-free at retirement is beautiful, so don’t forget to understand the impact financing a college education has on your retirement outlook.
Some final thoughts…
Don’t be the statistic! “Consumers 60 and older are the fastest growing age segment of the student loan market.” These loans are being taken out for kids and grandkids. Through careful planning and utilization of all available options, try to avoid these private loans causing the actual student loan debt crisis in America.
You probably have a gap between what you have and what you want to spend, but through careful college selection and the proper knowledge of how to pay for college with loans, your student can leave college with manageable debt.
Our rule of thumb is that you should never take out more debt for your education than you anticipate making your first year out of college in your chosen career.
Originally posted July 2017
Updated January 2023
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