What you should know about student loans

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 Q. My child is in 11th grade and she will be going to college. We’ve been saving but I know it won’t be enough. What do I need to know about student loans?

A. Congratulations to you and your daughter on the decision to pursue a college education.

And yes, paying for it can be a doozy.

There are three pillars to paying for college, said Jim McCarthy, a certified financial planner with Directional Wealth Management in Rockaway. The first is savings, the second is financial aid — which includes both merit and need-based aid plus grants and work study programs — the last is loans.

Before you start focusing on student loans, McCarthy said you should research any and all available financial aid. This starts with completing a Free Application for Federal Student Aid (FAFSA).

“You should complete a FAFSA application regardless of whether you think you will qualify for financial aid,” he said.

You can learn more here.

The deadline to file for the upcoming school year is June 30 of each year, he said. However, the deadline to qualify for New Jersey state tuition aid grants is June 1 of each year. He said he encourages clients to file well before the deadline – usually on January 2 each year.

“This accomplishes two things: (1) you will get a preliminary look at your Expected Family Contribution (EFC) – roughly how much the family is expected to pay towards the student’s tuition, and (2) The EFC is the factor that the schools you choose will use to determine how much aid your child might get,” McCarthy said. “When you file the FAFSA isn’t supposed to matter, but my feeling is getting on the financial aid line early can’t hurt.”

He said that filing in January, you will need to update your FAFSA once your tax return for the prior year is completed as the FAFSA is verified against IRS records.

You can estimate your potential EFC now by using The College Board’s EFC calculator.  You will need: your previous year’s tax returns and financial account information. Only non-retirement money counts (don’t include IRAs, 401ks, annuities, etc.), he said.

He said you should also focus on the net cost of attendance and shop for college(s) with a track record of providing financial aid.

“The U.S. government now requires most colleges to have a ‘net price calculator’ on their websites,” McCarthy said. “Check out the school(s) your child is interested in attending to see how much each school distributes in aid.”

You can learn more about that with The College Board.

You should also start looking for scholarships, too. McCathy recommends you use sites such as as www.fastweb.com and www.studentscholarshipsearch.com, some of which are specific to a college and others that are available regardless of college choice.

Lastly, he said, when the time comes, don’t be afraid to appeal to a college’s financial aid office for more aid than is offered.

Once you have explored all the financial aid avenues you can then turn to student loans.

“The first stop should be looking at Federal student loans, which include subsidized (no interest while in school) and unsubsidized loans (interest accrues while in school but payments don’t start until after graduation or leaving school),” McCarthy said. “Direct Loans are needs-based and taken out by the student. Direct PLUS loans are unsubsidized loans taken out by the parent(s).”

If more loans are needed, the next stop is Sallie Mae, which is publicly traded corporation that offers educational loans, McCarthy said.

“There are banks such as Wells Fargo and Discover that offer student loans,” he said. “The terms — interest rate, payment schedule, etc. — from these providers are not as favorable as Federal student loans and should be avoided if at all possible.”

Peter McKenna, a certified financial planner with Highland Financial Advisors in Riverdale, said any borrowing should be done with care.

“If the borrowing is going to be a weight around the student’s or parent’s necks for decades to come it may not be the right long-term decision for your family,” he said. “Current rules do not allow forgiveness of student loans in bankruptcy, so the decision to borrow must be entered very carefully.”

As a rule of thumb, the total borrowing at graduation should be less than the student’s anticipated starting salary, McKenna said.

While there may be other repayment options, think about the borrowing in terms of how much the monthly payment would be to pay off the loan in ten years after graduation, he said.

“The monthly payment is approximately 1 percent of the amount borrowed at graduation, so a $20,000 student loan will cost about $200 each month for your daughter’s first ten years after college,” McKenna said. “Always think about the borrowing in terms of how much it will grow to, with interest, over the four years.”

Given all this, with the cost of a college education today, borrowing is often required, even for those in middle and upper income brackets, he said.

So you need to carefully weigh your borrowing options.

“Subsidized Stafford loans are the least expensive option, but eligibility is determined through the FAFSA process and fairly low income and asset levels are needed to qualify,” McKenna said. “Unsubsidized Stafford loans are probably the next best option.”

He said the Stafford loans are the borrowing of the student, all of the other options involve the parent co-signing on the loan.

You could also consider a home equity loan, which would pledge your home as collateral.

“If you have a good credit rating or substantial home equity, you may be able to borrow on a private loan at rates or terms that are better than the Federal Plus program,” McKenna said. “If you or the student can deduct the interest expense on your taxes, the after-tax expense will be lower. You and/or your accountant should review the rules and income limits to see if it is deductible.”

When your daughter is considering schools, it will make sense to review the cost of attendance figures that each school provides, McKenna said. These estimates will allow you to compare the top line costs between schools, but you won’t know the bottom line costs until you know if she qualifies for any grants or scholarships at each institution.

“An in-state public college may prepare the student for life at a lower cost than private college,” he said. “Completing the course of study in four years and living simply while in school will help to keep borrowing costs low.”

While a two-year start at a community college may make financial sense, make sure the credits will transfer and that graduation in four years is likely, he said.

Good luck!

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This post first appeared in March 2015.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.