Student Loans - The Basics
Student loans have been a hot topic in the last few years. Recent headlines have compared the rapid increase in student loans with the subprime mortgage crisis of 2007, which many believe triggered the great recession in the years that followed. Left unchecked, could rising student loans cause a similar chain of events? Like subprime loans a decade ago, student loans are often issued without consideration of the ability of the borrower to repay. Given this striking comparison, it is wise for students and parents to understand the type of loans they are using, the loan options available, and the difference between them.
To address these issues, I will be writing a series of articles related to savvy college planning and loan repayment options. Let’s start by reviewing some student loan facts and figures.
Nationally, 69% of undergraduates recently graduated with an average student loan debt of $28,950. This balance increased dramatically for graduate level and doctoral studies1.
At the end of 2015, the national student loan debt was over 1.3 trillion dollars2 and has increased at double the inflation rate over the last 10 years1.
If student loan interest rates were as low as home mortgage rates and had the same long repayment terms and debt forgiveness, I probably wouldn’t be addressing this issue. The fact is that most student loans carry very high interest rates that in 2015 ranged from 4.29% for undergraduate loans to 6.84% for graduate and professional loans. With short repayment terms, these loans can easily be as high as some mortgage payments.
To make matters worse, there is an increasing number of students who attend college, take out loans, and never complete their course of study. These individuals are then stuck with repaying this high debt often without the benefit of well-paying jobs. Unlike many subprime loans, student loans are not dismissed in bankruptcy.
For current students or parents seeking student loan options, there are two primary lender categories: the federal government and private lenders. Federal student loans are the predominate choice because they provide more stable interest rates and flexible repayment options.
Once you select your lender, another decision to make is whether to choose a “subsidized” or “unsubsidized” loan. It is important to understand the difference between the two.
Subsidized loans are when the lender pays the interest that accrues while the borrower is in school. Subsidized loans are only available for undergraduate students, and may not exceed their educational financial need. Once the student graduates, there is an interest repayment grace period of up to 6 months.
Unsubsidized loans do not have the favorable interest payment options while in school, and interest accrues with no interest deferment options.
Certainly if given the choice between subsidized loans or unsubsidized loans choose subsidized.
Since student loans are not dismissed through bankruptcy, repaying a student loan is a life commitment and it’s important to understand the impact of the debt incurred.
In my next article, I’ll discuss ways to reduce the need for student loans by properly planning for college and reducing expenses.
Caleb Griffith, CFP®, is a Senior Financial Advisor at Townsend Asset Management Corp., a registered investment advisory firm offering comprehensive wealth management expertise to its clients. Email: Caleb@AssetMgr.com