Funding College – should you go private or federal?

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Funding college - should you go private or federal?An unlikely change resulting from the recent Health Care and Education Reconciliation Act of 2010 relates to the federal student loan program. Beginning the first of July, 2010, all student loan lending through the Federal Family Education Loan Program (FFELP) will originate from the federal government’s Direct Loan program. This means that private banks will no longer be able to make government-backed loans to students and their families. The intent is to streamline the process, which was often confusing and sometimes misused by dishonest lenders.

What difference will the changes make?

The process of applying for college loans is now simplified into a single system. You won’t have to shop around to find a lender offering the most competitive rates and loan rate terms. Remember the 2007 student loan scandals, which revealed that lenders were providing university kickbacks to be on a ‘preferred lender’ list handed out to students and parents? Well, those are long gone.

It’s important to remember too that private educational loans also often came with variable interest rates, no caps, high origination fees, and less flexible repayment terms – all features the Stafford loans were designed to eliminate.

So what’s the College Loan Process now?

The process won’t change – students and parents will fill out the Free Application for Federal Student Aid (FAFSA) to apply for Stafford loans, which are unsubsidized loans made directly with the federal government. Interest rates are fixed at 6.8% (the same as in 2009-2010) and no credit check is required.

Stafford loans have limits:

  • freshman can borrow no more than $5,500

  • sophomores can borrow no more than $6,500

  • upper-class undergrads can borrow no more than $7,400

  • the lifetime cap remains at $31,000

When your student reaches these limits, parents can apply for a Parent PLUS loan, which is also available through the FFELP (the federal government). The rules on PLUS loans are slightly different, however. Parents are required to pass a credit check and sign a promissory note. The interest rates on PLUS loans is now fixed at 7.9% (reduced from the previous 8.5%), which is great for parents.

How does Repayment work now?

The new health bill also contains some provisions for future repayment of college loans that will help low-income borrowers. Borrowers taking out student loans on or after July 1, 2014 can choose a repayment plan that is income-based, with an accelerated duration of 20 years instead of 25.

2010 Graduate – current repayment rules
$40,000 in student loans
standard 10-year repayment schedule
6.8% interest rate
= Graduate pays $460/month

Post 2014 Graduate – new repayment rules
$40,000 in student loans
standard 10-year repayment schedule
6.8% interest rate
married with a child
earning less than $27,000 (150% of poverty level)
= Graduate pays $160 per month and any unpaid balance is forgiven after 25 years.

Note! These changes do not affect current borrowers.

Should You go with a Private Loan?

It depends. First, many parents expect their children to assume some of the debt related to their higher education and, in that case, your student should fill out the FAFSA which will entitle them to Stafford Loans and their relatively easy terms.

After that, if you want to borrow in your own name, you should generally consider the PLUS loans because of the relatively low interest rate (7.9%). If you prefer to borrow educational funds for your children from a bank where you have a personal relationship, you may be able to get a better interest rate than those offered by the PLUS loan program.

A word of caution, however: many private student loans have typically held variable interest rates in the past. While some private lenders are returning to the incentives they abandoned during the credit crisis, it’s important to understand the terms before you sign the loan agreement.

Of course, it’s important to remember that saving for your child’s education comes after saving for your own retirement and security needs. Losing sleep over how to pay for college pales in comparison to losing sleep over how to pay for your own retirement.

So, the most important rule is to take care of your own needs first.

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