Student Loans: A Lesson in Personal Finance

Racine Journal Times / June 2007

At a meeting two weeks ago, I finally understood the consequences and seriousness of the college loan scandal between universities’ financial aid offices and private loan lenders. During the meeting, the clients produced a loan agreement for their granddaughter at a local college to cover her tuition expenses. As I read through the fine print, I about fell out of my seat when I came across the annual interest rate which was in excess of 16%.

According to the student, the financial aid office recommended this particular loan when she asked for help. She thought the financial aid officer was helping her so she didn’t question whether the loan was the best option available. This experience opened my eyes to the seriousness of the problems with financial aid offices and student loan companies.

In March, the attorney general of New York, Andrew Cuomo announced he was investigating universities across the country for steering their students towards certain lending institutions in return for money from the institutions. At the time, I found this practice disappointing because of the trust placed in financial aid offices at the universities by students but none of the articles I read discussed the impact on students.

I strongly urge students and parents to do their homework before signing any new loan documents. A little bit of research would have reduced our client’s granddaughter’s interest rate by half or more. When it comes to loans for college, students and parents have a variety of options with different costs.

The first step is to apply for government loans which tend to have the lowest interest rates. While the most favorable terms are based on students’ financial needs, there are loan programs that are available without regard to financial need. In order to receive any federal loan, the student must complete the Free Application for Federal Student Aid (FAFSA) which is available after January 1^st each year. A new calculator called the FAFSA4caster is now available to project the expected financial aid students can receive for college and can be found at www.fafsa4caster.ed.gov.

Federal student loans are divided into three major options: Stafford loans, Perkins loans and PLUS loans. The Stafford loans can be either subsidized (which means the government pays the interest on the loan while the student is in college) or unsubsidized where the students pays all the interest but can wait until after graduation to begin making payments. Subsidized Stafford loans are based on financial need whereas unsubsidized loans are available to all students. There are limited amounts available based on the student’s year in school and the interest rate is fixed for the life of the loan (which was a new change as of July 2006).

Perkins loans are awarded based on financial need with the government subsidizing the interest while the student is in college. The interest rate for Perkins loans are less than Stafford loans. The third federal loan option is for parents of students to borrow money through the PLUS loan program. This has the highest interest rate of the three options but offers the most money for borrowers. It also requires parents to sign the loan unless it’s for graduate or professional students.

If none of these three options are available or sufficient to cover a student’s expenses, then private student loans are another alternative. These are the loans under investigation because they are offered by a variety of lending institutions with a wide range of interest rates and expenses. I strongly recommend students and parents review the details of these types of loans just like they would a car loan or mortgage.

Lenders must provide disclosures showing the Annual Percentage Rate (APR) and finance charges for the loan. This typically appears on the Truth-in-Lending Disclosure Form. It’s worthwhile to comparison shop between lenders and colleges cannot force students to only use certain lenders (even if they have a “preferred lender” list).

In summary, I recommend the following actions for students and their families:

1. apply for federal loans via the FAFSA
2. review all private loan Truth-in-Lending Disclosure forms before signing any documents
3. visit www.finaid.com for further information on student loans and other ways to pay for college

Justus Morgan is a CERTIFIED FINANCIAL PLANNER™ practitioner with Financial Service Group, Inc., a registered investment advisory firm in Racine, website address www.toyourwealth.com.