Loans for College After you ve applied for financial aid and have received your results (your award letters), you may find that you still have a gap an unmet need. Sometimes even the amount that the federal government says you can afford (your EFC or Expected Family Contribution) is out of reach. Fortunately there are ways to bridge this all-too-common gap. This minimanual will focus on one of them - loans. Loans are a great way to make college possible when it might otherwise not be. But unlike other types of financial aid, loans have to be repaid with interest. Learn the facts about loans so you can borrow wisely, and end up with the loan that offers the most advantages possible. First, you need to understand some terms: Defer: Some federal loans let you defer or delay paying the loan back until after you graduate. Interest rate: The interest rate is the cost of borrowing money, and is usually a percentage of the loan that is added to the amount you borrow. The higher your interest rate, the more you'll owe over time. Need-based: Aid that is need-based is awarded to students who are determined to have financial need; that is, the amount they are able to pay for college is less than the cost of attending the college. The federal government offers need-based loans to students. Eligibility for these loans is determined by submitting a FAFSA form. Subsidized: Some federal loans are subsidized, which means the government pays the interest on the loan while you're in college. Here s a link to even more loan and aid terms: https://bigfuture.collegeboard.org/pay-forcollege/financial-aid-101/financial-aid-glossary-learn-the-lingo The federal and state governments, colleges and private organizations all provide college loans to students and parents. This manual provides a high level overview of the types of loans that are available, but you will need to do your own research and perhaps seek outside advice in order to make the best decision for your family s situation. Loans can be categorized in different ways. You can categorize them into those based on need, and those not based on need. Or, you can categorize them based on source, whether federal or private. For our purposes we will take that approach, and discuss need based vs. non need based as well, within each category. There are two major types of loans: Federal Education Loans: available to students and parents Non-federal Loans (private): these might be home equity or other bank loans Federal Loans (guaranteed by the federal government) What is Title IV? This term refers to a section of the federal Higher Education Act of 1965, as amended, which authorizes the vast majority of federal student financial assistance programs. Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 1
Title IV student financial aid programs are offered by most institutions that are accredited by an accrediting agency that is recognized by the U.S. Secretary of Education. It is important to note that not all accrediting agencies are recognized by the U.S. Secretary of Education. Students attending institutions that are accredited by agencies not recognized by the Secretary are ineligible to receive aid from the federal Title IV student financial aid programs. The Title IV loan programs are discussed below. What does it mean when it says the loan is guaranteed by the federal government? It means that if the student defaults on the loan (fails to pay it back), the government will reimburse the lender. That protects the lender, so in return, the interest rates are lower. The government also pays interest while the student is in college if the loan is subsidized. Within the Federal loan category, there are two overall types: Need-Based Loans Federal Perkins Loans may be awarded by colleges to students with the highest need. Federal Direct Subsidized Loans* are interest-free while you're in college and have a borrowing limit that increases for each year of school you complete. The current interest rate is 4.29%. Non-Need-Based Loans Federal Direct Unsubsidized Loans* charge interest, but allow you to add the interest fees to the amount you borrow until after graduation. However, doing this means you ll actually end up owing more. Federal Direct PLUS Loans allow parents (or graduate students) to borrow the total cost of college, minus any financial aid received. *Federal direct subsidized and unsubsidized loans may be referred to as Stafford loans Need Based Perkins Loans The Perkins loan is awarded by participating colleges to students with exceptional financial need. The maximum amount for this loan is $5,500 per year with an aggregate maximum of $27,500 per student. These loans carry a fixed interest rate of 5% as of this printing. These loans are repaid starting 9 months after the student leaves school or reduces his or her enrollment to less than half time. During the school years, no interest is charged and the student has 10 years to repay the loan. These loans are government loans, yet they are administered through the aid offices of the various colleges. The financial aid office of each college gets to determine who receives them and for how much each. These loans are very good deals and should almost always be taken if offered, but they tend to go to those with very high need levels. Non-Need-Based: PLUS (Parent Loan for Undergraduate Students) First of all, these loans are for parents, not students. (As of this printing, graduate students are eligible as well.) These are credit-based loans and are hard to beat if you are lucky enough to qualify. It s all about the credit test. If qualified, parents can borrow up to the total cost if attendance at college minus any other financial aid received. Again, remember that these are not need-based, so income is not a factor. The current interest rate is 6.84% as of this printing. Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 2
Use of PLUS Loans This federal loan is offered through colleges to parents with relatively good credit. Parents often use PLUS loans to cover some or all of their EFC, which is the government s assessment of what you can afford to pay. Interest, Fees, and Limits The interest rates on these loans are fixed and the interest begins accruing immediately. Repayment of PLUS loans begins 60 days after the loan is received, and may extend up to 10 years. Sometimes a co-borrower is permitted. The loan money is sent directly to the school in at least two installments. After payment of tuition, fees, room, board and other charges is made, the balance of the loan is sent to the parents or, if authorized, to the student. There is no maximum borrowing limit on PLUS loans, but a school can refuse loans or can certify amounts that are less than what the parent would otherwise have been eligible for. If this happens, the school must document and explain in writing the reason for the decision. In addition, the student may be eligible for a higher loan limit if the parents are restricted on the PLUS loan. The current interest rate on this loan is 6.84%, but is variable based upon the ten-year treasury note. The rate is capped at 10.5%, and repayment begins shortly after the funds are disbursed. The maximum PLUS loan amount is the difference between the college s cost of attendance and all of the other aid that your child has been awarded. How to Apply Parents apply for PLUS loans by filling out and submitting a special application and promissory note. They can usually obtain the required forms from the college financial aid office, or can try the lenders themselves or the Department of Education financial aid websites. (see www.studentaid.ed.gov) Although a FAFSA is not required for a PLUS loan, it is still recommended because it is required for other forms of aid. To qualify, parents must be U.S. citizens or eligible non-citizens and they must certify that the loan is to be used solely for educational purposes. Keep in mind that it's important to understand all the terms of any loan before you accept it. See the table below for a breakdown of each type of loan and its current interest rate. Loan Direct Subsidized Loan Direct Unsubsidized Loan Direct Unsubsidized Loan Need- Based? Subsidized? Sponsor Yes Yes Federal government No No Federal government No No Federal government Perkins Yes Yes Federal government Borrower Student - undergraduate Student - undergraduate Student - graduate/professional Student Interest Rate (Loans disbursed after July 1, 2015) 4.29% (fixed) 4.29% (fixed) 5.84% (fixed) 5% (fixed) Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 3
Direct PLUS Loan State and Private Loans No No Federal government No No Banks, colleges, foundations, state agencies Parent (or graduate/professional student) Usually student with creditworthy cosigner 6.84% (fixed) Usually higher than federal rates; variable The U.S. Department of Education provides comprehensive information about these federal loans at https://studentaid.ed.gov/sa/types/loans The federal government's Perkins Loan and the Direct Subsidized Loan are need-based loans that may be offered to eligible students. Federal need-based loans are often the best choices for the following reasons: The government supports your education by subsidizing the loan (paying the interest fees while you re in college). These loans often provide low interest rates. They allow you to defer repaying any money until you re out of college and, hopefully, earning an income. They don t require a credit check. They may provide better benefits than private loans. So if you qualify for this type of loan, choose it first. Below are a couple of excellent publications from the federal aid website: studentaid.ed.gov https://studentaid.ed.gov/sa/sites/default/files/direct-loan-basics-students.pdf https://studentaid.ed.gov/sa/sites/default/files/federal-loan-programs.pdf How to Apply for Direct Federal Loans The first step in applying for these student loans is to complete the FAFSA (Free Application for Federal Student Aid). The FAFSA requires Social Security Number, Drivers License Number, and tax return information. File as early as you can after January 1 of the year the student will attend college. (Note: The FAFSA filing dates will be changing for the 2017-18 year. You will be able to file the previous October instead of January 1, and you will be able to use your latest tax return as opposed to estimating the current one. Keep an eye on these changes.) Ideally, have your current tax return already completed. Visit www.fafsa.ed.gov for helpful information, worksheets, etc. You can also sign the FAFSA electronically which has many benefits. To do so, you will need an FSA ID. Visit https://studentaid.ed.gov/sa/fafsa/filling-out/fsaid to obtain your FSA ID, which enables you to apply for an monitor your federal aid activity. As you apply for the FAFSA and make other aid-related inquiries, beware of websites that look official but are really offering FAFSA or other services for a fee. Be sure that you are indeed on the official site. www.fafsa.ed.gov Based on your calculated need, your aid package from one or more of your colleges may include a federally guaranteed loan IF you have completed a FAFSA. In a recent NACAC (National Association of College Admission Counseling) survey, most college counselors indicated that they believe student loans are a good investment for a typical student at Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 4
their school, assuming he or she needs financial assistance in order to attend. (83% indicated good while 37% indicated very good ) The Master Promissory Note (MPN) If you receive a federal loan offer, you must accept it by signing a federal Master Promissory Note or MPN, which is a contract between you and the lender. When you sign a MPN you are agreeing to the terms and conditions set forth, and you will be stating that you understand your responsibility to repay the loan as specified. The MPN also spells out loan fees, late charges, repayment options, legal rights and what occurs if you default on the loan. Usually only one MPN is needed for all education loans received over a 10 year period, but check to be sure. If you receive a direct or indirect loan from the same lender every year while you re in college, the same MPN should be able to serve as your sole loan contract. This is a nice convenience. In addition, the MPN can be completed on line and loan funds can also be disbursed electronically if desired. Always keep a copy of your MPN. If you receive loans from other sources, you will probably have to fill out specific promissory notes for each. The PLUS and Perkins loans, though federal, still have their own forms. Always ask questions before signing these promissory notes, to be sure you understand all terms. Monitor your Loans at NSLDS You can monitor your loans and grants at https://www.nslds.ed.gov/npas/index.htm. The National Student Loan Data System (NSLDS) is the U.S. Department of Education's (ED's) central database for student aid. NSLDS receives data from schools, guaranty agencies, the Direct Loan program, the Pell Grant program, and other Department of ED programs. NSLDS Student Access provides a centralized, integrated view of Title IV loans and Pell grants so that recipients of Title IV Aid can access and inquire about their Title IV loans and/or Pell grant data. Using this tool you can keep an eye on your total loan limits. (See our separate manual for information about grants, as opposed to loans.) Non-Federal Loans State Loans To learn about college loans that may be available from your state, use the contact information on the U.S. Department of Education's list of state contacts at: http://www2.ed.gov/about/contacts/state/index.html Private Loans In general, private loans are not subsidized or need-based. They also often require a cosigner someone who promises to repay the money if the student fails to do so. The interest rates of private loans vary: Banks and other financial institutions usually have the highest interest rates. Some private organizations and foundations offer lower interest rates. Here is one tool for searching: https://bigfuture.collegeboard.org/scholarship-search Some colleges offer loans with relatively low interest rates. http://www.finaid.org/loans/studentloan.phtml Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 5
Private Loan Terms Private loans are not guaranteed by the federal government. Another key characteristic of private loans is that they are not based on need. They are designed to help pay for the net gap or EFC. In most, if not all, cases they must be repaid starting immediately and they have interest rates that are generally higher than federal loans. In addition, the interest rates on private loans can fluctuate. These sorts of loans have terms that are entirely controlled by the lender and they can differ significantly. As such, private loans may require more effort on your part. Most of the time, the primary borrower on a private college loan is the student. Parents may be able to cosign in order to help obtain the loan, but it s advantageous to allow the student to establish good credit. You might be able to negotiate terms such that the cosigner is released from obligation after the student makes a certain number of on-time payments. There are other terms that can vary for private loans. For example, you may be able to defer repayment until after the student graduates but, unfortunately, interest will be accruing the entire time most likely. These are the types of terms that you must be sure you fully understand. Ask questions of your lender, and don t sign anything until you are absolutely sure you understand your obligations. Finding Lenders There are all sorts of private lenders and it s worth shopping around. If you have a good relationship with your bank or credit union, that s a good place to start. Also, check with your colleges as they will often recommend certain lenders with whom they have had positive experiences. In fact, some colleges have their own lending programs with attractive interest rates. Sallie Mae offers a good college loan website at www.salliemae.com and several private education loans to supplement the federally sponsored loan programs. Compare rates, fees and discounts and remember to fully understand terms. For example, it might be better to get all fees waived as opposed to a reduced interest rate. Try to do the math yourself to be sure. What Determines Eligibility? You are generally able to borrow the amount of your net gap, or your total educational expenses minus any aid you received. However, various aspects of your loan, such as fees, interest rates, etc. are tied to the borrower s credit and that of the cosigner if applicable. Yes, that s right the better the credit rating the lower the interest rate in many cases. It is highly unlikely that you ll find a private loan where the interest is deferred. It will almost certainly begin accruing immediately. Be careful when making these sorts of commitments, and seek professional advice if need be. Do I Need a Cosigner? If you are turned down when applying individually, a cosigner may save the day. If you have no credit history, or poor credit, this could be the case. But in addition, some lenders have a tiered interest rate structure where excellent credit can make a large dollar difference. So if you have someone with excellent credit who is willing to cosign for you, investigate your options thoroughly and shop around. Cosigner Responsibility Cosigning a loan makes you as responsible as the other party for repayment so it s a large responsibility not to be taken lightly. The cosigner guarantees the debt and will have to repay it if the borrower does not. If you are considering cosigning a loan, be very clear about this and be sure you want to accept the responsibility. Ask yourself: Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 6
Can you repay the loan if need be? Are you willing to risk your credit rating if you need to repay and cannot? Your liability for the debt may be included in other lenders calculations, making you less eligible for other loans you might want even if you never have to repay this one. Lenders must give you paperwork that clearly explains your responsibilities and obligations as a cosigner. Be sure to read them carefully as well as all the loan documents and the Truth-in Lending Disclosure Statement. Private Loans as Aid from Colleges Sometimes private loans can be offered through the colleges as part of their aid award package to the student. Because they come from the college aid office, don t be confused into thinking they are federal loans. They might be, but might not as well. Remember that you don t have to accept the loans in order to attend the college, so shop around regardless of what the college disperses. If it is a federal loan, it is likely to be attractive in terms of interest and terms. If it s a private loan, you may not be getting the best deal. Remember that if you do decide to accept a loan offered in your award letter from the college, it isn t automatic. You have to apply for it and the instructions should be included in the material sent to you. The College Preferred Lender List Almost all colleges will provide some sort of preferred lender lists that single out four or five lenders for you. These are supposed to be lenders that the college s financial aid office has determined will provide the best deals and service to its students. As such, the lenders on these lists typically receive up to 90% of the loans taken out by that school s student /parent population. However, it is wise to beware and be aware. Recently investigations showed that some lenders have been paying their way onto school lender lists and some schools were receiving kickbacks and other perks as well. Hopefully colleges are remedying this situation if they were ever a part of it, but you can ask the tough questions and be sure. Don t automatically reject lenders that are on a preferred list, but don t automatically accept them either. In other words, ask questions and shop. Remember, you are not obligated to use a lender the school suggests. State Loans Sometimes there are lower-cost loans based on the state of residence and/or where the student will be attending school. These are usually attractive options if available, so research your particular state thoroughly before resorting to private loans. If you don t know where to start, try an internet search using your state plus terms such as higher education commission or higher education financial aid. For example, New Jersey Higher Education Commission and this may lead you to the source. From there, look for financial aid links. Mortgage and Home Equity Loans It is not uncommon for parents to take out a new mortgage on their home in order to pay for college. After all, most parents have the majority of their net worth tied up in their homes and their 401k or other retirement plans. A cash-out refinance of a mortgage is when the borrower refinances an existing loan by taking a new mortgage for an amount that is higher than the existing loan. The lender then pays off the existing mortgage and gives the borrower cash-out of their home in the Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 7
amount of the difference between the new higher loan and what was owed on the existing loan. By contrast, re-mortgaging a home simply means to take out a new loan equal to what is currently owed, but usually at a different interest rate and a different period of repayment. Essentially the goal in re-mortgaging an existing loan is to reduce the payment by getting a lower interest rate, stretching out the payments over a longer period of time, or both. Instead of taking a mortgage against your home, you can also tap into your home s equity by taking a home equity loan where you get cash-out up front and have a variable or fixed interest rate for a fixed period of time. Or you can get a home equity line of credit (HELOC). A HELOC is a line of credit that you can draw on when you want, and then make payments according to the amount of the available credit that you use. The interest rate is usually variable. Mortgages can come with fixed, variable and adjustable interest rates, and typically offer longer terms of repayment than home equity loans. One good thing is that the interest can be tax deductible for most taxpayers who itemize their deductions on their tax return. However, ALL of these loans are collateralized by your home, and if you can t make the payments on the loan, the lender can foreclose on the loan and you can lose your home. Intra-Family Loans The two big advantages of this type of loan are typically lower interest rates and little or no paperwork to get approved for the loan. They also have one big downside, which is the fact that you are borrowing from your family and if you don t repay the loan according to the terms agreed upon it can cause stress within the family. Life Insurance Policy Cash Value Loan Whole life, variable life and universal life insurance policies all have a cash value component that can be borrowed against. The interest rates for loans on these types of policies will vary among companies and policies, but generally range from 5%-9% annually. As the owner of the policy, you determine when to repay the loan. However, if you don t at least pay the interest on the loan each year, the interest charges from the loan will begin to eat away at your cash value and could eventually put your policy at risk of having insufficient cash value to stay in force over time, even if you continue to pay the normal premiums. 401k Loans In most households these days, at least one parent has a 401k retirement plan through their employer and makes regular contributions to the plan directly out of their paycheck. Most of these plans have a loan provision that permits account owners to borrow from their savings. The maximum loan by law is 50% of the vested account balance, and must be repaid within five years through payroll deductions. The interest rate is set by the plan and is usually tied to the prime rate. The problem with 401k loans is that you have to repay them over such a short period of time (five years). If you fail to do so, the unpaid balance of the loan is treated as a non-qualified withdrawal and therefore is subject to ordinary income tax rates plus a 10% excise tax (penalty) if you are not over age 59 1/2. Borrowing against your retirement savings through a 401k for example, is different than tapping into a retirement plan, and taking distributions from the plan to pay for college. If you are considering tapping your retirement savings to pay for college, remember that your child can borrow for college but you cannot borrow for retirement. Moreover, with increasing taxes and low yields on fixed income investments, you ll need all the retirement savings you can put away. Depleting your retirement funds to pay for college is not usually a wise decision. Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 8
Interest-Free or Low-Interest College Loans Some charities and religious or ethnic organizations offer low or even no interest college loans. Here are just a few: Evalee C. Schwartz Charitable Trust for Education students attending in state school and whose families have EFCs under $4000, high test scores and grades and not intending to pursue legal careers. www.evaleeschwarztrust.org Deadline: April The Scholarship Foundation of St. Louis meritorious students from parts of Missouri and Illinois whose families have EFCs under $12,000. www.sfstl.org Deadline: November Bill Raskob Foundation US citizens attending accredited US colleges after freshman year. www.billraskob.org Deadline: May Abe and Annie Siebel Foundation Texas residents attending Texas schools and who have good grades and test scores. (use internet search to locate) Deadline: February These sorts of private loans come and go, so research to see what might be available to you. Summary of Loans for Students Various studies have shown that when students are at least partially responsible for paying for their own college education by way of work-study, using their own money or taking out student loans they tend to do better academically than students who are not responsible for any share of their education costs. As parents, if you want your child to be responsible for paying a part of her college costs and they will need a loan to do so, you can either lend them the money yourself (Intrafamily loan) or let them take out a student loan. Depending on whether they demonstrate a financial need for student aid, exceptional financial need, or no financial need at the college that he or she attends, they will end up with a subsidized or unsubsidized loan, a Perkins loan, and/or a private student loan. In general, the best loans are the subsidized loans followed by the unsubsidized loans, and generally as a last resort, private student loans. Special offers from lenders change constantly for private student loans, so it may require some homework using the internet and by talking with your college to determine which lender has the best overall rates, origination fees and repayment terms. Summary of Loans for Parents Generally, mortgages offer the longest terms of repayment with the lowest interest rates, and the interest for some taxpayers is tax deductible. For these reasons, mortgages frequently have the lowest monthly payments for a given amount of borrowed money. Home equity loans and lines of credit (HELOCs) have to be repaid over shorter periods of time at higher rates of interest, so their payments tend to be higher than mortgages. But remember that all of these types of loans require a credit check and are collateralized by your home. Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 9
Intra-family and life insurance cash value loans don t require a credit check and can often be paid back on more flexible terms and favorable interest rates. Parent PLUS Loans are a good option for parents who don t have a home or any family sources. Also, a Parent PLUS Loan might be better than a mortgage or home equity loan in some cases because the loan isn t collateralized by your home, the interest rate is fixed, and the loan is insured against the borrower s death and disability. 401k loans have to be repaid over shorter time periods (five years) than other loans, usually have a higher rate of interest than home loans, and the interest is not tax deductible. So as you can see, some private loans might offer relatively low interest rates, but their other terms might not be as favorable as those of a federal loan. For example, federal loans generally offer flexible terms if you don't have a job or become disabled, you might be able to adjust your payments while private loans may not be as flexible. Do your own research carefully and, if possible, seek advice from a financial advisor prior to deciding on a particular loan option. Note: The financial information in this manual is of a general nature and may not apply to all situations. Contact a financial and/or tax advisor before making significant decisions. This manual is kept as current as possible, but you should always verify current interest rates, terms, and limits yourself. Copyright 2017 All rights reserved. (For 2016-17 Academic Year Use Only) Page 10