As this year’s high school seniors in the US tackle their college applications, it is time to think about student loans. In the US, this is a badly broken system, and it is important to be aware as you consider the “financial aid” (including loans) that your student will be offered.
The first problem, of course, is just that it is a burden for young people to start their working lives with large debt. The average graduating senior has about $30,000 in loans. With a decent job, this could be manageable, but keep in mind that any graduate degrees are yet to come, and these are the ones that truly add the cost. Student loans can be in the hundreds of thousands of dollars after graduate school, and this truly impacts a life.
However, even beyond that concern, there are also significant systemic problems in federal student loans that you need to keep carefully in mind:
1. Interest rates, even on federal loans, can be as high as 8%. This is twice or more what you might pay on a house or car loan today, and it dramatically affects not just your payment amount, but also how fast an unpaid balance will grow.
2. If you get a deferment or forbearance on your loan, in almost all cases interest will continue to be charged while you are not paying. A loan balance growing at 8% will double in less than 10 years.
3. The same is true for an income-driven repayment (IDR) plan. This widely touted “solution” to high student loans allows your loan balance to continue to grow if your payment is less than the interest due (which is quite possible). In some cases, the government can “capitalize” this interest – in other words, add it to your principal. You will then be paying interest on the interest, and your loan balance will grow even faster.
4. While the IDR plans forgive loans after 20 or 25 years of payments, in most cases, the forgiven amount will be taxed as income. Particularly given the previous points, a borrower could wind up with a tax bill after “forgiveness” that is comparable to the original loan amount.
5. Possibly most importantly, be aware that there is no solution after the fact if you get in over your head with student loans. In addition to the problems with income-based repayment and loan forgiveness, these loans cannot be eliminated by bankruptcy – even if you file, you will still be responsible for them.
In addition to all this, the Department of Education actually limits the amount of loan counseling that can be offered to students, and many people go into it without the knowledge they need to take care of themselves.
The federal student loan program is an outrage that desperately needs to be fixed, but until that happens, please be careful! When the time comes to choose a university for your student, be realistic about what your income and savings can cover. There are literally thousands of excellent universities in the US – choose one that won’t haunt you financially for decades to come.
I have two local workshops in November to discuss the costs of college and how to cover them:
November 10th – an evening workshop called “Paying for College”. We will review the costs of college, and go over your questions, concerns and goals for your child’s education. I will also provide a list of additional resources for this important stage.
November 12th – “FAFSA Filling-Out Party”. Many universities use the Free Application for Federal Student Aid (FAFSA) to determine their merit scholarships, so it is important to submit this form even if you will not qualify for need-based aid. If you would like some help filling it out, join us for an afternoon workshop to get it done. Financial Aid Director, Dr Tom Melecki, will also join us for an hour of Q&A about financial aid.
Details of both of these are on my website and my Facebook page. Please join me, and if you have friends with children in high-school, tell them as well!
If you have any questions at all, give me a call or email. And if you know someone who would like help sorting out their finances, please do send them my way. I greatly appreciate your referrals.
Originally published October 2016