College tuition costs have continued to rise tremendously over the past few decades, and rising costs can have a hefty impact on payment strategies. Families tend to utilize a combination of tools for college expenses that include at least some of the following: savings and income, loans, and scholarships. While it’s wise to borrow as little as possible, sometimes savings and income simply won’t cover all the expense. For this reason, loans and scholarships remain popular options to cover remaining costs that may have been overlooked or unexpected.
Families often look to federal loans first upon learning that college financing will be needed. Federal student loans offer some benefits not typically provided by private loans, including fixed interest rates that may be lower than that of a private loan; more flexible repayment plans based on income level; possible loan cancellation “for certain types of employment”; and deferment options. Keep in mind that Congress is responsible for the setting of federal loan interest rates with the exception of the Federal Perkins Loan.
Federal Direct Subsidized Loan: As a report from CNN points out, students may be in better shape to take out a loan such as a subsidized Direct Loan, which is typically utilized by undergraduate students with higher financial need. A student taking out a federal Direct Loan will pay a fixed 4.45% interest rate, and may borrow up to $5,500 a year.
Direct Unsubsidized Loan: An unsubsidized Direct Loan is available to undergraduate, graduate, and professional degree students, and unlike a subsidized Direct Loan, this loan can be obtained regardless of financial need. Undergraduates are subject to a 4.45% interest rate, while graduate and professional degree students must pay a 6% interest rate. The maximum amount allowed to borrow is much higher than with a Direct subsidized loan; up to $20,500 can be borrowed annually, although the Department of Education notes that this maximum is “less any subsidized amounts received” for the same period.
Direct PLUS Loan: This type of loan is another loan not based on financial need and is specified for parents of dependent undergraduate students and graduate or professional degree students. This loan takes credit history into consideration and the interest rate is 7% for loans paid out between July 1, 2017 and July 1, 2018. The borrowing maximum is specified by the Department of Education as the “maximum amount is cost of attendance” minus the amount of separate financial aid received by the student.
Federal Perkins Loan: This is a needs-based loan for undergraduate, graduate, and professional degree students. With this loan, the student’s educational institution is the lender rather than the Department of Education, and the student will pay a 5% interest rate. Undergraduate students may borrow up to $5,500 each year, and graduate and professional students may borrow up to $8,000 a year. The Department of Education notes that with this loan, the “total lifetime limit may not exceed $27,500 for undergraduates” or “$60,000 for graduate students,” which included funds borrowed as an undergraduate student.
The Free Application for Federal Student Aid (FAFSA) is most often the best place for families to start when looking at federal financing options.
For families with healthy credit scores who can obtain a low interest rate, a private loan could be a better deal in the long run. Interest rates can be as low as 3% or as high as 14%. It’s not always likely that a private education loan will have a lower interest rate than a federal loan. Discover, Sallie Mae, and Wells Fargo are among the top lenders for education loans.
Private loans do not require a FAFSA to be filled out, but it’s a good idea to complete a FAFSA for informational purposes. Keep in mind that private loans do not offer the flexibility that some federal loans have to prevent loan defaults, so it’s important that parents make sure their children understand the details and implications of what could be their very first loan. Parents considering a private loan for college should examine their other options carefully. As previously noted, one method sometimes used for private financing for college – taking out a home equity loan, or HELOC- may be a less desirable choice starting this year, as deducting the interest from this type of loan for tax purposes will not be possible until after 2025.
States often offer a number of grants and scholarships, as well as many private organizations and nonprofits. There are numerous scholarships available, and not all of them are based on financial need. Many students can benefit from merit aid if they can meet certain academic qualifications. Most of these scholarships will not be large amounts, but smaller scholarships can add up and reduce the overall cost. For some families, it can be beneficial to keep an eye on merit aid opportunities and focus on colleges that are offering aid specific to their child’s academic achievements.
While financial aid will help to fill gaps not covered by savings and allotted income, it remains important to work toward a plan that minimizes the need for financing. For families who are uncertain whether their savings plan will meet their needs, it can be quite valuable to discuss savings and investment strategies with a trusted financial planner to help develop and maintain a strategy that can address tuition costs without relying on financial aid.