The ins and outs of student loans

About two thirds of college graduates take on some kind of debt to pay for college, eventually walking across that stage with the help of student loans.Unless you’re very wealthy or a fantastic saver (in either case, good for you!), there’s a good chance that if you have kids, they’ll be taking on some kind of debt to pay for college. According to FinAid.org about two thirds of college graduates do, eventually walking across that stage with the help of student loans.

Which is to say, there’s no shame in having your kids borrow for college. You just have to do it right, meaning borrowing as much as you can from the federal student loan program before (if ever) turning to private loans: interest rates are fairly low, there are several repayment options, and student loans are, by and large, considered good debt by creditors.

Even if you stick within these guidelines, there are ways for you and your kids to navigate the system that will allow you to save on interest, minimize debt, and celebrate graduation with a bit more peace of mind:

  • Set a limit. When it comes to your kids’ future career goals, I’m sure you tell them that the sky is the limit. But the same should not be true for borrowing to pay for college. Mark Kantrowitz, one of my most trusted financial aid sources and the publisher of FinAid.org, has a couple rules of thumb he’s shared with me in the past. The first is to make sure that the total amount you borrow for college is less than your expected starting salary. If your kid is going to be a neurosurgeon, she can borrow a bit more (in fact, let’s be honest – she likely won’t have a choice). But if she wants to be a writer, her borrowing will need to be more conservative. Kantrowitz’s second rule: Try not to borrow more than $10,000 for each year you’re in school.
  • Weigh the options. There are a few for undergraduates, starting with federal loans for students. These come in subsidized and unsubsidized versions, and the difference is big: The interest (3.4% if you borrow between July 1, 2011 and June 30, 2012 according to studentaid.ed.gov) on subsidized loans, which are for students with financial need, doesn’t accrue while the student is in school. Interest on unsubsidized loans (a fixed 6.8%) does. Your other federal option is a PLUS loan, which carries a fixed interest rate of 7.9%, is borrowed by you – not the student – and has a repayment period that typically begins when the loan is fully disbursed. As always, you want to prioritize your options in order of cost to you: Scholarships, savings, subsidized student loans, unsubsidized student loans, PLUS loans. Private student loans come last.

    Why wouldn’t you just want to have your kid borrow all the money he or she needs in a subsidized loan if your family is eligible, and then help him pay that back? Because there are borrowing limits on federal student loans that might make this impossible. They’re $5,500 for first year undergraduates (with a $3,500 max on subsidized), $6,500 for second year ($4,500 subsidized), and $7,500 for third and fourth year ($5,500 subsidized).

  • Plan your payback. The best strategy is the quickest one, provided you or your kid don’t have more expensive debt like credit card bills. If you have unsubsidized or PLUS loans, you both want to start paying them back ASAP. (Students aren’t required to pay back unsubsidized loans until after graduation, but kicking in payments early will save money on interest. The only hitch, once you start paying you have to keep paying.) Those subsidized loans can wait until after graduation, because you’ll get more for your money elsewhere.
Jean Chatzky

About Jean Chatzky

Jean Chatzky, the financial editor for NBC’s TODAY show, is an award-winning personal finance journalist, AARP’s personal finance ambassador, and a contributing editor for Fortune magazine. Jean is a best-selling author; her eighth and most recent book is Money Rules: The Simple Path to Lifelong Security. She believes knowing how to manage our money is one of the most important life skills for people at every age and has made it her mission to help simplify money matters, increasing financial literacy both now and for the future. In April 2013 Jean launched Jean Chatzky's Money School , a series of college-style, interactive online personal finance courses that give men and women across the country the opportunity to learn from and interact directly with her. Jean lives with her family in Westchester County, New York.
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3 Responses to The ins and outs of student loans

  1. SaraJ says:

    A few years ago I would totally agree with everything you said; however, with student loan default on the rise and the dismal job market, perhaps student loans are not for everyone. The debt just may not be worth taking on if once students graduate and face the reality of paying back student loans with little to no job prospects.

    I can remember when I graduated in the 90′s, there was on-campus recruiting almost every week and 3 to 6 months before you graduated, almost every student had several viable job prospects.

    It’s rather sad, instead of economic times and opportunities increasing for younger generations, things just seem to be getting worse. I just read an article about student loan defaults are rising.
    Please note that Wells Fargo is not responsible for the information contained on the listed website. The site/article is provided to you for informational purposes only.

    The one hopeful aspect is that options exist to avoid default if graduates take advantage of them in time. There has got to be a cheapter way of paying for college. I wonder if work-study still exists?

  2. Jay Gould says:

    Student loans are well on their way to overtaking credit card debt. Americans are now paying down their credit card debt at a much slower pace than during the months immediately following the Lehman collapse in September 2008, but they continue to do so all the same. Additionally, the delinquency rate on U.S. credit cards – 3.04% in September, according to Moody’s, is at a record low.

    Falling delinquencies have led to lower defaults, which will keep falling for months ahead, even as the late payment curve may have bottomed out already.

    Moreover, the monthly payment rate (MPR), which measures the ratio of their credit card debt Americans are paying back at the end of each monthly cycle, was at 21.29% in September, compared to a historical average in the mid-teens.

    If that is the new normal, it will ensure that low delinquencies and defaults are also here to stay. Of course, there is also the possibility that, once we get back to full employment and consumer confidence improves, everyone will fall back into their free spending pre-Lehman pattern. Unfortunately, we are unlikely to be able to test our propositions anytime soon.

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