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These days, borrowing to pay for college has become a lot more defensive. Not only may student-loan terms be less attractive than they were in the past, but new graduates may also get squeezed if they have to begin repaying their loans before they land a job. Owing in no small part to the still-anemic economic recovery, the student loan default rate has been on the rise, according to the U.S. Department of Education (September 2012).
As with mortgage borrowers, student-loan shoppers face a bewildering array of options that carry varying interest rates, fees, and terms. In all, it pays to do your homework and investigate other alternatives before signing on the dotted line for a student loan.
Determine Your Need: The first step in the college-funding process is to determine how much of your child's education expenses your family will likely be on the hook for. Submitting the Free Application for Federal Student Aid (FAFSA) is the way to officially check on financial aid eligibility, and your specific package will vary by school.
Discuss the Payoff: If it looks like you and/or your child will have to borrow a sizable sum to cover the cost of college, it's wise to begin discussing those numbers in the context of your child's expected career path. If your child will graduate with $100,000 in student-loan debt but plans to venture into a field where starting salaries are in the $25,000 per year range, it doesn't take a math major to see that it will take many years to retire that debt, and doing so could impede your child's ability to reach other financial goals.
Know the Different Types: College loans come in a number of different varieties, but there are a few key categories to be aware of. The first choices for most students seeking additional funding are those extended by the federal government. Perkins loans are available exclusively to low-income students. Stafford loans come in two key varieties. With subsidized Stafford loans, students aren't on the hook for interest until after graduation, but with unsubsidized Stafford loans, interest begins accruing immediately. Students applying for subsidized Stafford loans must demonstrate financial need, whereas students needn't demonstrate financial need to qualify for unsubsidized Stafford loans. The second key category is federal loans made directly to parents, usually called PLUS loans. On the positive side, parents can typically borrow much more than students. However, interest begins accruing immediately and payments must also begin immediately. The final student-loan category is a private loan extended by a bank. In general, the cost of a private student loan can be much higher than that of a federal loan.
Don't Overestimate the Value of the Interest Deduction: You may have heard that you'll be eligible to deduct the interest on student loan debt. That's true, but don't overestimate the value of that deduction. In 2012, you can only deduct $2,500 in student loan interest per year; single parents earning more than $75,000 and married couples filing jointly who earn more than $150,000 per year cannot deduct the interest at all.
Consider Additional Options: Rather than assuming student loans are the only way to cover the cost of college, it's important to take a step back. Fully exploring financial aid packages, scholarships, and work-study programs can help reduce the strain that such loans can impose on families and new graduates; some grandparents may also have the wherewithal to help defray college costs. Parents may also contemplate tapping home equity lines of credit or using their own savings plans to fund college.
Please consult with a financial or tax professional for advice specific to your situation.