Critical Information On How Student Loans Work
If you have reached the juncture in your child’s college admissions process when you are thinking about student loans, we have to say, “Congratulations!”
While it may not be apparent right now, you have definitely made it through the hard part. The rest, figuring out how you’re going to close that financial gap and understanding all your options, is not that difficult if you are armed with the right information.
We recently spoke with Pete Wylie, VP of In-School Lending at CommonBond, who helped untangle what for many parents is a puzzling problem. We like to call this “Everything You Wanted to Know About Student Loans, But Didn’t Know What to Ask.”
What Is a Student Loan?
At the core, a student loan is like any other loan products that you may have taken or used before. You apply for them differently and use them differently, but in general, a loan is merely an amount of money that you are going to take at a certain point in time and repay in installments in the future. In addition, it has an interest rate, so while the money is outstanding it will accrue interest daily at whatever rate that interest is.
Key Points: Some products have fees at the outset…something that should be considered when you think about how you will be able to afford the product.
90% of all student loans are issued by the Federal Government.
What Are Federal Student Loans?
The Direct Student Loan Program has been in existence since 2009. It is broken down into loans for undergraduate/graduate study and loans that are made directly to parents. There are different rates for undergrads and grads, and for parents (Parent PLUSLoans) borrowing for their children.
The loans that the federal government provides to students come in two forms: Subsidized and Unsubsidized. Most families who have some means and a reasonable income won’t have access to the subsidized product, and interest does not capitalize in the same way for both as well.
How Do You Know Which Federal Loan You’ve Received?
You can realize your need through the award letter process. That letter should clearly delineate what the award is, whether it is Subsidized or Unsubsidized, and what the amount is.
Key Point: Everyone who fills out the FAFSA, regardless of their income level, has access to a maximum of $5,500 for their Freshman year. The federal government caps the amount for undergraduates and allows grad students to borrow up to the cost of attendance. That $5,500 limit for undergrads is often not enough to cover the funding gap students have. Most families facing that gap will very often need to fund the tuition either with ongoing income/savings or some other borrowing. This usually means Parent PLUS loans from the federal government or private loans.
All federal products have one fixed interest rate per product and the standard repayment level is 10 years. The 2019-2020 federal student loan interest rates are currently 4.53% for undergraduate loans, 6.08% for unsubsidized graduate loans and 7.08% for direct PLUS loans. This is the lowest cost loan that will be available to you as a family to fund the education for your child, so it is strongly recommended to max out that loan before you check into other funding options. If you feel like you are going to borrow at any point in time during your child’s course of study, consider taking that loan when it is offered.
Key Point: Pete points out that there is more flexibility in the system than people realize. Keep in mind that if you feel you’ve made a mistake for one reason or another, you can cancel the loan with no penalty for 120 days after the first installment is released. Some schools even offer tuition payment plans that you can fund monthly. Ask them about that.
What Are Federal Loans For Parents?
Loans that parents can take through the federal government are Parent PLUS loans.
They are issued at one fixed rate for everyone: 7.08%, however this is just the “sticker price.”
These loans have an “origination fee,” and when that is factored in, the resulting rate on a 10-year loan jumps to 8.5%.
Parent PLUS loans are in the parents’ names and cannot be transferred to the child. CommonBond, and many other lenders offer private loans that are cosigned.
They are in the child’s name, and are the child’s responsibility.
Until the child can demonstrate repayment ability after they graduate and get a job, the parent has to lend their credit to them to get access to the funds.
(After the child has shown payment ability, generally after a few years, the parent/cosigner can be released.)
Key Point: 98% of the time, if there is a gap in payment for the Freshman year, that gap will remain for the remaining years of study. Parents must look at a 4-year cycle rather than a 1-year cycle since the debt can affect their own financial profile down the road.
Federal vs Private Loans?
The federal government provides one fixed rate to everyone, regardless of a family’s situation.
In private lending (as with car or home loans), many different pieces of a family’s financial history are factored in (credit history, current income) and the rate that is produced is based specifically on that history.
That is why very often, private loan rates can be lower than the federal rate.
Private loans offer flexible repayment options: Different scenarios for different families, and they also offer 5-, 10-, and 15-year repayment options.
Some private lenders will offer their customers the ability to fully defer until after graduation, as well as options that can further keep down the costs that families will incur over time.
What Is “Bundling?”
This is a somewhat “shady” thing schools do when they include the Parent PLUS loan as part of the award letter. What may look like an endorsement from the school implying that this is the best loan option for you as a family, in actuality it may not be. Because the Parent PLUS loan can be acquired rather simply, Pete encourages families to first look at their other options and research what their private loan interest rates will be.
Key Point: It is rare, but some schools offer their own direct private student loans at very good rates, so check with your school.
What Does the Process of “When the Funds Get There” Look Like?
This is usually driven on a school-by-school basis that depends on the school’s funding cycle. Schools will request the funds directly from the government so they can get them to the student before the bill arrives. Keep in mind that the federal government processes thousands of applications, and they are not infallible. If you sense a mistake has been made, contact the Financial Aid Office.
When Are Payments Due?
Payment of Parent PLUS loans can be deferred until after the student is out of school —regardless of whether that is after one or four years. (“Out of school” is the key term here.) Payments can be paused during gap years or if time is taken off from school, but interest will still continue to be accrued. The first payment is not due until after the loan is fully disbursed to the student. For the vast majority of colleges, this occurs with the spring or winter disbursement.
Cosigned private student loans that are available have very different flexible payment options…from interest-only to fully deferred. (See more about CommonBond’s repayment options for length and term.)
Timing/Can You Apply “Too Early?”
Pete recommends never waiting closer than a month to apply. Those who do not have more conventional income streams—partnerships, commission-based jobs, inheritances—will have their financial history placed under a little more scrutiny, so more time may be needed for processing. For all others, the approval process can go much quicker and can happen in as little as 24 hours.
There is something called the “Right to Cancel Period,” that gives private loan applicants a five-day window in which they can cancel their request.
It is for this reason that lenders must wait for that same amount of time as well in case there is a cancellation.
Pete recommends parents wait to apply until they understand exactly how much the out-of-pocket amount is that is needed.
Be mindful of when funds are due and when you will need to access the money. As a rule of thumb, most people apply after July 4th until mid-August.
Can We Count on the School’s “Preferred Lenders List?”
Some schools devote more time than others in vetting the lenders on their lists, however regardless of that, this list should not be looked upon as a “Best Of” list. Think of it merely as something that is sent out by the school listing lenders who provide the products that fit the needs of the institution. You can use this list as a resource, but it would still be in your best interests to do your research.
Can You Take Out a Loan to Cover the Cost of Off-Campus Housing?
You can borrow up to the cost of attendance at the university in question. The process that governs this is the school’s own number that they have calculated to be the cost that on-campus living would incur. They do not generally consider the cost of off-campus living in their equation, and they will not certify or agree to give you more than that original number.
Key Point: Student loans have a lot more protection than either car or home loans do.
Should something unfortunate happen to a student, there are protections that have been put in place: Deferment and Forbearance are two programs that allow you to stop payment on your loan for 12 to 24 months depending on the program.
Everyone runs into hard times, and it is comforting to know that student loan lenders understand that.
There is also something called Death/Discharge where companies (like CommonBond) make no attempt to collect in the case of a student’s death.
These are important features and should be considered when comparing loan companies and their policies.
The private loan market offers variable rate products, and while for now, that is a positive, these interest rates are subject to change…and not necessarily in a good way. Some families might feel more secure sticking with the stability of a fixed-rate product such as that which is offered by the federal government. Do your homework, do your research, and honestly assess your family’s situation and level of comfort.
There is no rush! None of these bills will be due until August, so there is still more than enough time to do your research and comparison shop.
It goes without saying that the interest rate of a loan is the most important thing to consider, but customer service is also crucial.
When you consider that you and your loan company may be “together” for upwards of ten years, you want to be confident that the lender will offer lots of options.
You should have a good relationship with someone who will be responsive to your individual needs at different points in time during the course of the loan.
So, sometimes, the absolute cheapest option may not be the best.
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To hear more about Student Loans, watch the discussion with Pete Wylie of CommonBond here: