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Tue, Jun 1, 2010

Ideas & Trends

Making Financial Aid Pay Off (Part 2)

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On May 22, Fastweb celebrated its 15th anniversary since first bringing scholarships to the internet in 1995.  Since its founding, Fastweb has helped over 50 million students pay for school, and today there are more than 9 million active members.

To celebrate this milestone, we sat down with Mark Kantrowitz, publisher of Fastweb, to answer the top questions parents and students need to know about planning and paying for college (second in a series):

Q: For parents who own a home, are Home Equity Lines of Credit (HELOC) a smart option for funding college?

Families should always borrow federal first, as federal education loans are cheaper, more available, and have better repayment terms. The interest rates on federal education loans are fixed, while the interest rates on private student loans and home equity lines of credit (HELOC) are variable. The current unusually low interest rate environment will not last, so the interest rate on a variable rate loan is sure to increase significantly within the next few years. Since HELOCs and private student loans are usually repaid over 15-30 years, you should be concerned about the average interest rate over the life of the loan, not just the current rates. Unless you are planning on paying off the loan in full within the next three years, fixed rate federal education loans are a better bet.

The federal student loans offer a variety of flexible repayment terms. These include in-school deferment of principal and interest payments, subsidized interest on need-based loans, the economic hardship deferment and forbearances, income-based repayment, extended repayment terms, public service loan forgiveness, and discharges for closed schools, death and total and permanent disability. Up to $2,500 in student loan interest may be deducted on your federal income tax return each year. The interest is deducted as an above-the-line exclusion from income, so you can benefit from it even if you don’t itemize.

Finally, using a home equity loan or line of credit puts your home at risk. If you default on a HELOC, the lender can foreclose on your home. If you default on a student loan, the lender cannot repossess your education.

Q: Can parents still qualify for federally subsidized loans if they can’t prove financial need?

Federally subsidized loans like the subsidized Stafford and Perkins loans are student loans, not parent loans. To receive these loans the student must demonstrate financial need. Financial need is calculated after the family submits the Free Application for Federal Student Aid (FAFSA) by subtracting the expected family contribution (EFC) from the college’s cost of attendance. The EFC is based on family income and assets, household size, the number of children in college, and the age of the older parent.

If the applicant’s EFC is high enough that they don’t qualify for need-based financial aid, the applicant will not receive subsidized student loans. However, the unsubsidized Stafford loan and the PLUS loan do not depend on financial need, so you do not need to be poor to qualify for these low interest rate loans.

Q: What is the difference between Unsubsidized Stafford loans, Parent PLUS loans and subsidized loans?

While the student is in college, and during the grace period after graduation, the federal government pays the interest on subsidized loans like the subsidized Stafford and Perkins loans. On unsubsidized loans, like the unsubsidized Stafford and PLUS loans, the borrower is responsible for the interest. If the borrower chooses to not pay the interest as it accrues, the borrower can defer it by capitalizing it. This adds the interest to the loan balance, increasing the size of the loan. Subsidized loans also have lower interest rates than unsubsidized loans.

The Stafford loan (both subsidized and unsubsidized), Perkins loan and Grad PLUS loans are student loans, where the student is obligated to repay the debt. The Parent PLUS loan is a parent loan, where the parent is obligated to repay the debt. The loans also have different annual and aggregate loan limits and different interest rates.

Q. The recently passed health care bill included changes with education loans, what are those changes and how do these legislative changes effect students and parents?

The Health Care and Education Reconciliation Act of 2010 ends the federally-guaranteed student loan program, replacing it with direct lending. All new federal education loans starting July 1, 2010 will be made through the Direct Loan program, where loan funds are provided by the federal government through the college’s financial aid office. This includes Parent PLUS loans, which have a lower interest rate and a higher approval rate in the Direct Loan program. The loan origination process is smoother, and it saves the federal government some money. The savings will be used to prevent cuts to the Pell Grant program. The savings are also used to cut the monthly loan payment under the income-based repayment plan by one third starting in 2014, and to accelerate the loan forgiveness from 25 years to 20 years. Families do not need to take any special steps to take advantage of these changes, other than submitting the Free Application for Federal Student Aid (FAFSA). Call your college’s financial aid office if you have any questions about the Direct Loan program.

Q. Are federal loans renegotiated at the beginning of each new term to add the new year’s tuition or do parents need to get a brand new loan each year?

When you first borrow from the federal education loan programs you will need to sign a Master Promissory Note (MPN). The MPN covers all loans during a continuous period of enrollment at a single college.

You will need to submit a new FAFSA every year since each year’s financial aid package is based on a new snapshot of your family’s financial situation. The Stafford loan’s annual loan limits also increase as the student progresses from freshman to sophomore and from sophomore to junior and senior years in school.

Unfortunately, there will be a new loan each year you are in school. But after you graduate you can refinance them into a single loan called a consolidation loan.

Q. If the accepted student signs the Award Letter is he/she obligated for the cost of the tuition in the unfortunate event parents cannot secure funding?

Refund policies vary from college to college. Some colleges provide a full refund if the student withdraws within the first 30 days of the academic year and no refund if the student withdraws after the first 30 days. Other colleges prorate the refund based on the number of weeks into the semester. Look on the college’s web site or course catalog for its refund policy.

Federal student aid is earned on a prorated basis up until 60% of the way through the semester, at which point it is treated as 100% earned. If you withdraw before the 60% mark any unearned aid will have to be returned. There is a preference order that returns loans before grants to minimize the loan burden on students who have to withdraw.

Since the college’s refund policy may differ from the federal government’s policy on earned aid, you may end up owing the college some money if you withdraw. You will also owe the family contribution portion of college costs.

If the parents are denied a Parent PLUS loan because of an adverse credit history, the student becomes eligible for increased unsubsidized Stafford loan limits, the same loan limits that are available to independent students. These loan limits are $4,000 higher per year during the freshman and sophomore years and $5,000 higher per year during the junior and senior years.

To be continued…

Miss part 1?  Click here to learn more tips on making financial aid pay off.

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