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Student loan guide

As federal rates rise on most student loans, it's good to know your options.

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Every parent dreams that his or her child will seize the brass ring: a college education that kick-starts a career and a promising future. But these days, that dream is being tarnished by America’s student debt crisis.

The average annual cost of a four-year public college, including tuition, fees, and room and board was $17,860 for the 2012–2013 school year, and $39,518 for a four-year private institution, according to the College Board.1 No wonder 70% of the class of 2013 is graduating with college debt, according to a recent Fidelity study.2 Furthermore, nearly four out of ten students would have made a different college choice and pursued different savings strategies had they understood the consequences of that burden.

Taxpayers pay a price, too. About 17% of student loan borrowers were at least 90 days past due on their student debt in 2012, a large increase from under 10% in 2004, according to a March 2013 report by the Federal Reserve Bank of New York.

Families feel the strain as well. Student loan debt now tops $1 trillion, with the average borrower owing $27,000. Add in a tough jobs market, with one out of seven new four-year college graduates underemployed in May 2012,3 and it’s not surprising that nearly six million Americans ages 25 to 34 lived with their parents in 2011, according to a November 2011 study by the U.S. Census Bureau.

A brief reprieve

On August 9, 2013, President Obama signed legislation granting a reprieve—at least for the next year—on scheduled interest rate hikes for students who take out federally subsidized Stafford loans—now numbering about 10.4 million undergrads. The legislation will hold rates on both subsidized and unsubsidized Stafford loans to 3.86% until July 1, 2014. Otherwise, they would have jumped from last year’s rate of 3.4% to 6.8%.

Other changes recently, either as part of new legislation or because certain features were allowed to expire, include the following:

  • Rates on subsidized and unsubsidized Stafford loans taken out in subsequent years will be set at 2.05 percentage points above the yield on the 10-year Treasury note, and capped at 8.25% for undergraduate students.
  • The six-month grace period on interest upon graduation for subsidized Stafford loans was eliminated for the 2012-2013 and 2013-2014 academic years.
  • Graduate students will no longer be eligible for subsidized Stafford loans, and their rates for unsubsidized Stafford loans will drop to 5.41%, with a cap of 9.5%.
  • Graduate students and parents of dependent children taking out federal PLUS loans will face stricter standards to qualify.
  • Interest rates for parents and grad students taking out PLUS loans will drop to 6.41% this year, from 7.9% last year. Going forward, rates could rise, but would be capped at 10.5%.

What to do

“The key is to think ahead and figure out how much in college expenses you can afford,” says Keith Bernhardt, vice president of college planning at Fidelity Investments. (Read Viewpoints: How much college can you really afford?).

Once you have determined how much you can afford, focus your application process on colleges that fit your budget. Fill out the Free Application for Federal Student Aid (FAFSA) form to find out what grants, scholarships, and financial aid packages each college offers based on your family’s expected contribution. Finally, compare total costs.

“If you need to borrow, look first at student federal loan options, because they generally have better rates and repayment terms,” says Bernhardt. Also, consider looking at state-sponsored loans, or visit your state’s higher education office. For a listing of such institutions, visit Ed.gov.

Borrowing options

When shopping for federal student loans, keep in mind that there are two types: need based and non–need based. Federal Perkins loans and subsidized Stafford loans are need based. Federal parent PLUS loans and unsubsidized Stafford loans are not, although parent PLUS loans face eligibility restrictions. Consider each of these loan programs, as well as taking out a home equity loan or line of credit, if available (see below).

In financing your student’s college education, it’s important to shop based on a variety of factors, including loan availability, interest rates, loan terms, and flexibility of payments. For example, let’s say you need to borrow $30,000. As you can see in the chart right, your interest rates and monthly payments can vary considerably—but so can the structure of your payments, including when you start and when the final payment is due, as well as your ability to qualify.

Federal loan options

Let's take a closer look at the options for federal student loans.

  • Perkins loans—These loans are awarded to students with the highest need, based on a combination of parental income and other factors. Perkins loans are offered to undergraduates for up to $5,500 a year with a lifetime maximum of $27,500. Graduate students can borrow up to $8,000 a year,with a maximum of $60,000, including the loans they took out as undergrads. The interest rate is fixed at 5% and there are no origination fees. Borrowers have up to 10 years to repay, depending on the amount owed.
  • Subsidized Stafford loans—Eligibility for these loans is determined by FAFSA. Typically, they are offered at set amounts for each school year—from $3,500 for the first year up to $5,500 in the third year and beyond—with a lifetime limit of $23,000. As of July 1, 2013, the interest rate is about 3.86%, but it could rise next year. Interest begins accruing upon graduation or leaving school. Standard repayment is a 10-year term, but borrowers can apply for extended repayment options of 10-to-30 years, depending on the amount owed.
  • Unsubsidized Stafford loans— To receive these loans, students must be enrolled in a qualifying degree or certificate program. Interest rates are 3.86% for undergraduate students for the 2013-2014 school year and 5.41% for graduate students, with extended repayment options of up to 30 years, though borrowers must apply and be qualified for extended repayment options such as income-based repayment. Loan limits vary from $2,000 to $12,500 a year for undergrads, with a lifetime limit of $31,000 for dependent undergrads and $57,500 for independent undergrads. Unlike subsidized Stafford loans, interest on the unsubsidized variety accrues from the time they are disbursed, rather than when the student leaves school.
  • Parent PLUS and graduate student PLUS loans—These loans carry a 6.41% fixed rate in the 2013-2014 academic year, and are available to graduate students and to parents of undergrads. Unlike Stafford loans, PLUS loans require underwriting, and standards have tightened. To qualify, recipients cannot have an adverse credit history, which includes bankruptcy and unpaid collection accounts and charge-offs. You can appeal a denial by providing added documentation or an endorser. Undergraduates whose parents are denied a PLUS loan are eligible for an additional $4,000 to $5,000 in unsubsidized Stafford loans a year. The bad news is that those who are denied a PLUS loan are unlikely to qualify for private loans. Loan terms can range from 10 to 30 years.

Beyond federal loans

Keep in mind that there are other college financing options beyond federal loans.

  • Private student loans are available, but they typically carry variable interest rates as high as 12%, and they often reset each quarter. Unlike federal loans, most come with a repayment period of up to 20 years, versus 10 to 15 years for federal student loans. Plus, private loans typically are stricter in their selection of borrowers—your credit rate may cause you to pay a higher or lower interest rate, or be denied for a loan altogether. Still, private student loans may be an option for some students, especially if they can qualify for a lower rate.
  • State-sponsored student loans are loans that have your state’s stamp of approval. These loans vary from state to state, but in general are designed with the consumer in mind. Interest rates vary, but generally they range from 6% to 8.5%. Some states offer attractive features like interest rates that are fixed or the absence of tiered rates that are based on the borrower’s credit score.
  • Home equity lines of credit or home equity loans are another popular option. Home equity lines of credit carry a variable interest rate averaging about 4.95%; the rate on home equity loans is fixed, averaging 6.05%, as of August 1, 2013, according to Bankrate.com. With the equity line, you can borrow the money as you need it, which can be less expensive than an equity loan. Either way, the advantage over education loans is that you can deduct the interest on home equity debt up to $100,000 for debt taken out to pay for college.
Consider your options: Highlights of different types of student loans
Type of loan Who's eligible Interest rate
(2013)
Loan limits
Yearly/lifetime
When accrual begins Years to pay
Perkins Loans Only the most needy college students 5% Undergrads: $5,500/$27,500
Grad students: $8,000/$60,000
When student graduates or leaves school Up to 10
Subsidized
Stafford Loans
Determined by Free Application for Federal Student Aid (FAFSA) 3.86%* $3,500–$5,000/$23,000 When student graduates or leaves school 10–15
Unsubsidized
Stafford Loans
Everyone who files a FAFSA Undergrads: 3.86%*
Grad students: 5.41%*
Undergrads: $2,000–$12,500/$31,000
Grad students: $2,000–$20,500/$57,500
Begins when student accepts the loan, but payments can be deferred until after the student graduates or leaves school 10–15
Parent PLUS
and Graduate
Student PLUS Loans
Those who meet the eligibility requirements and do not have an adverse credit history 6.41% Undergrads and graduate students: the cost of your college’s annual tuition, room and board, minus financial aid Begins when the loan is disbursed, but payments can be deferred until after the student graduates or leaves school 15–30
State-Sponsored
Loans
Each state has its own eligibility requirements. Some states require that a student attend college in that state. Varies by state, but generally from 6% to 8.5% Varies by state, creditworthiness, and choice of borrower Either immediately upon acceptance of loan terms or after the student graduates or leaves school 10–20
Private Student
Loans
Depends on creditworthiness Varies, but generally from 2.5% to 12% Depends on each institution, credit- worthiness, and choice of borrower Either immediately upon acceptance of loan terms or after the student graduates or leaves school 10–30
Home Equity
Loans
Depends on creditworthiness and equity in home Average 6.05% fixed rate† Depends on each institution, credit- worthiness, and choice of borrower Immediately 10–30
Home Equity
Line of Credit
Depends on creditworthiness and equity in home Average 4.95% variable rate† Depends on each institution, credit- worthiness, and choice of borrower Immediately 10–30
Source: : Edvisors.com; bankrate.com; FinAid and Fidelity Investments. *As of 7/1/2013. †As of 8/1/2013.

Tips for students

For students already enrolled in college, or graduating with outstanding debt, here are tips to understanding, managing, and paying off loans:

  1. Understand the terms and conditions of your loans and be sure to meet your monthly payments.
  2. Take advantage of private and government websites and resources, and explore alternatives designed to lower payments and tuition management assistance programs.
  3. Visit the National Student Loan Data System to keep track of your loans and financial services provider.
  4. Opt to repay your student loans automatically to avoid penalties. Repaying the student loans automatically not only avoids late fee but may also yield a slight interest rate reduction. 
  5. Pay off the highest interest rate loans first to save money in the long term.

Tips for parents

For parents, it’s critical to make sure helping their child pay the college tab won’t shortchange their own home, retirement savings, or other short- and long-term financial goals. “Parents must do a trade-off analysis and remember they can borrow for college but not for retirement,” Bernhardt suggests.

Considering the mounting burden of student loan debt, most financial experts concur that the best way to reduce the burden is to launch a college savings strategy for your child as early as possible.

The good news is that there are tax-savvy accounts that can help you save. Among them:

  • 529 college savings plans, offered by states and financial institutions nationwide, allow you to save after-tax dollars, but that money can grow tax free and be withdrawn federal income tax free to meet qualified higher education expenses such as tuition, books, room, and board at accredited colleges nationwide. There is no annual contribution limit for 529 college savings plans except for the overall total contribution maximum, which can vary by plan but is typically over $300,000. However, to avoid paying federal gift and transfer taxes, as an individual you can contribute up to $70,000 per beneficiary by utilizing five-year gift-tax averaging; or $140,000 for a married couple.4 (For more detailed analysis, read Viewpoints: The ABC’s of 529 college savings plans).
  • Custodial accounts, either Uniform Gifts to Minors Act (UGMA) accounts or Uniform Transfers to Minors Act (UTMA) accounts, offer more investment choices, but weigh more heavily on financial aid. They offer limited tax benefits, and the money saved becomes the child’s at a certain age, regardless of whether he or she goes on to college.
  • Coverdell Education Savings Accounts (ESAs) offer tax-free growth and are designated for a child’s educational expenses, but annual contributions are limited to $2,000 per beneficiary. Still, if you’re contributing only $2,000 or less per year, these savings vehicles can be attractive, particularly because they offer a broad range of investment options. (Note: Fidelity does not offer Coverdell ESAs).

In the end, the more you save, the less you have to borrow. You don’t want your newly minted college grad trapped in a debt bubble that could limit his or her financial future.

Learn more

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2. Fidelity College Savings Indicator, Summer 2012.
3. From “The College Advantage: Weathering the Economic Storm.” Georgetown Public Policy Institute, Center on Education and the Workplace, August 2012.
4. In order for an accelerated transfer to a 529 plan (for a given beneficiary) of $70,000 (or $140,000 combined for spouses who gift split) to result in no federal transfer tax and no use of any portion of the applicable federal transfer tax exemption and/or credit amounts, no further annual exclusion gifts and/or generation-skipping transfers to the same beneficiary may be made over the five-year period, and the transfer must be reported as a series of five equal annual transfers on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. If the donor dies within the five-year period, a portion of the transferred amount will be included in the donor's estate for estate tax purposes.
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