The Money Class (9 page)

Put a financial safety school on your list
. Guidance counselors are quick to talk about applying to at least one school your child will easily be accepted into. I would take this strategy one step further and make sure you have a financial safety school: Plan on applying to a public in-state school that you know will be affordable. A public four-year school can cost one-half to one-third what it costs to attend a private four-year college. If your child qualifies for a generous financial aid package at a private school, that’s great. But the idea here is that in the event the aid package at an expensive school isn’t generous enough, you will have an affordable option to fall back on.

Strive to make the most of high school
. Once you explain your financial situation to a high school freshman or sophomore you give them even more incentive to do well in school. Every A they receive now can help them qualify for financial aid. Advanced Placement classes can also help all of you save on college costs: Many colleges will waive some basic required courses for students who score well on the AP test.

TIP:
Mark Kantrowitz, the wizard behind
FinAid.org
, also has the inside scoop on winning scholarships to offset tuition costs. If you have a child in high school, I would recommend you take a look at his new book,
Secrets to Winning a Scholarship
. The price is under $10 because Mark wants it to be available to everyone, including low-income families who could benefit the most. I approve!

Start the loan conversation
. In the next lesson I will explain the best ways to borrow for college. One of the hardest steps in this process is for you and your child to limit what you borrow for school. Just because someone will loan you $40,000 a year—and yes, you can borrow that much or more—does not mean you should. As a family you must stand in the truth that the goal is for your child to emerge from college without anyone in the family being saddled with so much debt that they will not be able to reach their other financial dreams.

BORROWING RULES FOR COLLEGE LOANS

As I stated at the beginning of this lesson, college is a smart investment. And I absolutely believe that college loans are “good debt.” But too much of a good thing can become a bad thing. You and your children need to borrow wisely. One of the problems with the college loan system is that there are not any checks and balances to prevent you from borrowing more than you can afford. That just makes it all the more important for your entire family to stand in the truth—together—and create a borrowing plan that will allow both student and parent to easily handle the eventual payback of the loans. You need to understand that college debt, whether it is taken out by the student or the parent, is currently not eligible to be discharged in the event you file for bankruptcy. It literally stays with you forever. See what I mean: You need to really be careful in how you borrow for school, and how much you borrow.

Most families will qualify for some amount of need-based financial aid. You can get an estimate of what your family might qualify for here:
http://bit.ly/a6VEJ
. We all know that it is rare that your child will get a complete “free ride.” So your family will need to cover the portion of the bill that exceeds your aid. You can of course use your current income, as well as tapping any college savings funds, such as a 529. But it is also likely you will need to take out loans as well.

This is how you are to approach the loan part of the college financing puzzle:

• Student borrows first using a federal Stafford loan.
  
• Parent considers borrowing using a federal PLUS loan.
  
• Neither student nor parent uses a private loan
  

Please follow this strategy closely. Federal loans are the only loans you should ever take out. They charge reasonable fixed interest rates, and borrowers have a few different repayment plans to choose from, including plans that will allow you to defer, delay, or reduce your payments if you lose your job or experience financial hardship.

The Risks of Private Loans for College

Private loans offered through banks typically charge a variable interest rate. The starting rate is often higher than the fixed rate on federal loans. And listen to me here: General interest rates in the coming years are likely to move higher. When that happens, the interest rate charged on private student loans will also rise. That alone is enough reason to steer clear of private loans. But there’s another reason why I want you to stay away: If you fall into financial trouble once you are in repayment, private lenders have no obligation to help you out with a different payment schedule. What is most galling is that in the event a private loan borrower dies, the debt may still be owed. With federal loans, the debt is forgiven in the event the borrower dies or becomes permanently disabled.

My opinion is that private student loans should never be used. Period. If that means your child needs to consider a less expensive school, then that is the truth your family needs to stand in, united as one.

Alert: What to Do If You Already Have a Private Loan

If you already have a private college loan or you have cosigned for someone who has taken one out, I insist that you take out a term life insurance policy that can cover 125% of the current loan amount. As I just mentioned, in the event someone with a private college loan dies, the loan may not die. It is up to the lender to decide if it will still demand repayment. By purchasing a term life insurance policy, your family—or your cosigners—could use the death benefit on the policy to repay the loan. This is an incredibly cheap way to protect your loved ones. The term policy should be for a minimum of 10 years after the student is scheduled to graduate. Given that many borrowers need even longer to repay their college loans, I would recommend you consider a 15-year or 20-year policy. I also recommend that the amount of your policy be 25% or more than what you currently expect the loan’s expected total cost to be. Why? In order to provide some insulation from rising interest rates—remember the private loan is a variable rate—and the fees that the banking industry is expert at finding reasons to charge you. So for example, let’s say you have private loans that you expect will end up costing you $50,000 to repay. I would consider a 20-year level term life insurance policy with a death benefit of $62,000 or so. For a 20-year-old male in good health that policy might cost $10 to $12 a month. That’s it. Less than $150 a year to protect your loved ones from having to finish paying off your private student loan. And purchasing term life insurance is really simple. You can learn more at the websites of term insurance specialists
SelectQuote.com
and
AccuQuote.com
.

HOW TO BORROW FOR SCHOOL

When your child applies to college you should complete the Free Application for Federal Student Aid (FAFSA) form. Schools require the FAFSA form to determine your family’s eligibility for financial aid. It is unlikely that grants and scholarschips will cover all your costs. If you can’t make up the difference out of your current income or savings, your next move will be to take out loans. Families that meet a low-income test may be able to borrow up to $5,500 a year at a fixed interest rate of 5% through a federal Perkins loan; every school administers Perkins.

Student Borrows First: Stafford Loans

Your child is to borrow for school before you take out a loan. The federal Stafford loan program is hands down the best college financing deal out there that is available to everyone, regardless of need.

There are in fact two types of Stafford loans: subsidized and unsubsidized.

A subsidized Stafford loan
is based on financial need. For the school year that ends in July 2011 the fixed interest rate on a subsidized Stafford is 4.5%. For the 2011–2012 school year the fixed interest rate will be 3.4%. The interest rate for loans taken out in the 2012–2013 school year will be at a fixed interest rate of 6.8% and under current law will remain at that level in subsequent years. The government pays the interest on subsidized Stafford loans while the student is in school and during a six-month grace period after the student graduates (or leaves school). Once the student begins repayment he or she is responsible for the interest payments.

An unsubsidized Stafford loan
is available to all students regardless of financial need. The fixed interest rate is 6.8%, and the student is responsible for paying the interest while in school, or the interest can be added to the loan balance. My recommendation is to try to pay that interest while you are in school; a part-time job or maybe some help from mom, dad, or grandparents will help keep the loan balance lower so when repayment begins within six months of leaving school you will have a smaller balance to pay off. At
www.direct.ed.gov/student.html
you can find more information about Stafford loans, including calculators to help you estimate what your payments may be based on a few different plan options.

STAFFORD LOAN LIMITS

For the 2011–2012 year the student can borrow the following amounts based on their year of school:

I am fine with every student borrowing these maximum amounts. Graduating with a total of $27,000 in debt is not an amount that will bury you. A good rule of thumb is to keep your borrowing below what you expect your annual starting salary may be at your first job. Assuming the student has picked a field that pays a starting salary of $30,000 or more, paying back the Staffords is realistic.

Go to The Classroom at
www.suzeorman.com
:

Find guidance on my website about what factors to consider when determining how much young adults can honestly afford to borrow for college.

Parents Borrow Next: PLUS Loans

If the financial aid package and Stafford loans are not enough to cover the cost of school, your family’s next step is to consider the federal loan program for parents of college students: the PLUS program.

I think the federal PLUS loan program is terrific. It charges a reasonable fixed interest rate of 7.9%. There is also a 4% fee on the initial amount of the loan. Like Staffords, the PLUS program offers a few different repayment schedules based on your financial needs. Most important, if the parent dies or is permanently disabled, the loan is forgiven.

That said, not every parent should take out PLUS loans to help pay for college. In my opinion, you should meet the following standards:

• You pay off your credit card each month, in full.
  
• You have an eight-month emergency fund.
  
• You are on track with your retirement savings.
  

Please stand in the truth here: If you have not taken care of those financial priorities you are not in a position to borrow for a child’s college costs. Your financial security is not yet firmly in place. Borrowing more at this juncture would just put you further away from reaching those more pressing financial goals.

Qualifying Rules for PLUS Loans

Your FICO credit score is not a factor in qualifying for a PLUS loan. Your credit report will, however, be checked to confirm that you are current on all your payments—meaning no payments are ninety days past due—and that you have not declared bankruptcy or gone through a foreclosure in the past five years. (Short sales, however, are okay—you can still get a PLUS.)

If you are not eligible for a PLUS loan, you will want to notify the financial aid office at your child’s college; your child may be eligible for more aid from the school and could qualify to borrow more from the Stafford program. When parents are ineligible for a PLUS, the unsubsidized Stafford loan limit rises to $6,000 a year for freshmen and sophomores and $7,000 a year for juniors and seniors. At
FinAid.org
, which is run by college financing expert Mark Kantrowitz, you can learn more about all federal loans.

How Much to Borrow in PLUS Loans

One of the flaws of the PLUS program is that it does not set any borrowing limits based on your income. The basic rule is that you can borrow up to the total cost of attending school, minus any aid your child receives. But please, parents, do not tell yourself that you can afford any amount.