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Are Student Loans Still a Good Bet?

In the mid- and late-1960s, there was no doubt among U.S. public policy makers that the federal government should be encouraging more citizens to attend and graduate from college.

Bolstered by the success of the highly popular GI Bill, which paid college expenses for military veterans, federal student loans were hailed as a “GI Bill for all Americans.” These low-interest loans allowed students from modest means to attend college in numbers never before seen. The college graduation rate, which had hovered around 7 to 8 percent, steadily climbed to today’s rate of nearly 30 percent.

Backing the idea that higher education is nearly universally better than entering the workforce straight out of high school were statistics that showed that college graduates, on average, would benefit from as much as $1 million more in lifetime earnings than students who didn’t graduate with a post-secondary degree.

At the same time, however, the cost of a college education began to rise much faster than the rate of inflation, meaning that families began to have to devote more of their overall income to paying for college costs. With annual college tuition climbing into the tens of thousands of dollars, college expenses have outstripped even generous incomes, and students have had to turn increasingly to college loans to pay for their education.

Today, about two-thirds of college students take out student loans to help pay for their education. These students leave college with an average of $23,186 in school loan debt, according to FinAid.org.

This figure is less than the average cost of a new car in 2010 ($29,217), and most new car loans are paid off in five to six years, with an interest rate comparable to the rates on federal education loans.

So why are so many people concerned about the cost of college loans?

Simply put, not all college loans are created equal.

Federal education loans are issued directly by the federal government and carry a fixed interest rate, along with flexible repayment terms and multiple options for postponing or reducing one’s monthly payments based on one’s financial circumstances. Federal college loans are generally low-cost, low-pressure loans.

Private education loans on the other hand, which are issued not by the government but by banks, credit unions, and other private-sector lenders, are variable-rate, credit-based loans that typically carry higher fees and rates than their federal counterparts. Private student loans also offer much fewer, if any options, for financially distressed borrowers to be able to postpone or reduce their payments.

One major difference between a new car loan and a student loan is the deferment period. With a car loan, payments on the principal begin immediately. A portion of every payment is used to reduce the balance owed.

In contrast, all federal education loans and many private education loans allow students to defer making any payments while they’re still in school. The repayment of the loan can be delayed for years while the student finishes school – with no delay of interest charges, however.

Except in the case of subsidized federal student loans – for which the government will cover the interest while a student is in school and which are awarded only to students who demonstrate the most financial need – interest begins to accumulate on college loans as soon as the loans are issued, even if a student is deferring payments.

This accumulation may take place over months or years, quietly running up the balance on a student’s school loan debt to alarmingly high levels.

Families concerned with accumulating excessive college loan debt can always decline to take on any school loans. Federal college loans awarded in a student’s financial aid package are always optional; students can turn these loans down if they have another financial resource and don’t want to take on the debt of school loans.

Students forgoing their available federal college loans at the beginning of the school year, however, may end up passing on this government money only to see their financial circumstances change unexpectedly mid-semester. In cases like these, students may be forced to turn to private student loans to bridge the financial gap.

A good strategy for college students is to first seek out college scholarships and grants and then maximize their available federal student loans before considering a private student loan. Private loans should be considered only as a last resort and only for financial emergencies that arise during the semester that other sources of financial aid can’t cover.

Students should develop a clear and detailed plan for how they’re going to pay their college expenses for each year they attend classes, especially if they plan to decline the federal school loans in their financial aid packages.

Having a backup plan in place to cover unexpected financial emergencies can also help reduce the need for student loans, as well as the overall cost of a college education.

Paying for College: Student Loans or Credit Cards?

Research conducted by student loan company Sallie Mae shows that in 2010, about 5 percent of college students paid an average of more than $2,000 in tuition and other educational expenses using a credit card to avoid taking out student loans. The same study showed that 6 percent of parents used credit cards to pay an average of nearly $5,000 in educational expenses for their college children.

Is using credit cards a smart way to avoid college loan debt? Financial advisors are in near-universal agreement that the answer is no, but that isn’t stopping thousands of families from using credit cards in place of parent and student loans.

Some families might think that all debt is equal; others might think that they won’t qualify for college loans. So what advantages exactly do education loans offer over credit cards?

1) Availability

Particularly in the last few years, as credit card companies have tightened their credit requirements in a retraction of the lax lending that led to the foreclosure crisis, credit cards have become harder to qualify for, available mostly only to consumers with strong credit. Many consumers with weaker credit have had their credit lines reduced or eliminated altogether.

Federal college loans, on the other hand, are available with minimal to no credit requirements. Government-funded Perkins loans and Stafford loans are issued to students in their own name without a credit check and with no income, employment, or co-signer required.

Federal parent loans, known as PLUS loans, have no income requirements and require only that you be free of major adverse credit items – a recent bankruptcy or foreclosure, defaulted federal education loans, and delinquencies of 90 days or more.

In other words, don’t turn to credit cards simply because you think you won’t qualify for school loans. Chances are, these days, you’re more likely to qualify for a federal college loan than for a credit card.

2) Fixed Interest Rates

While most credit cards carry variable interest rates, federal student and parent loans are fixed-rate loans. With a fixed interest rate, you have the security of knowing that your student loan rate and monthly payments won’t go up even when general interest rates do.

Many credit cards will also penalize you for late or missed payments by raising your interest rate. Federal school loans keep the same rate regardless of your payment history.

3) Deferred Repayment

Repayment on both federal student loans and federal parent loans can be postponed until six months after the student leaves school (nine months for Perkins undergraduate loans).

With credit cards, however, the bill is due right away, and the interest rate on a credit card balance is generally much higher than the interest rate charged on federal school loans.

If you’re experiencing financial hardship, federal loans also offer additional payment deferment and forbearance options that can allow you to postpone making payments until you’re back on your feet.

Even most private student loans – non-federal education loans offered by banks, credit unions, and other private lenders – offer you the option to defer making payments until after graduation.

Keep in mind, however, that even while your payments are deferred, the interest on these private student loans, as well as on federal parent loans and on unsubsidized federal student loans, will continue to accrue.

If the prospect makes you nervous of having deferred college loan debt that’s slowly growing from accumulating interest charges, talk to your lender about in-school prepayment options that can allow you to pay off at least the interest each month on your school loans so your balances don’t get any larger while you’re still in school.

4) Income-Based Repayment Options

Once you do begin repaying your college loans, federal loans offer extended and income-based repayment options.

Extended repayment plans give you more time to repay, reducing the amount you have to pay each month. An income-based repayment plan scales down your monthly payments to a certain allowable percentage of your income so that your student loan payments aren’t eating up more of your budget than you can live on.

Credit cards don’t offer this kind of repayment flexibility, regardless of your employment, income, or financial situation. Your credit card will require a minimum monthly payment, and if you don’t have the resources to pay it, your credit card company can begin collection activities to try to recover the money you owe them.

5) Tax Benefits

Any interest you pay on your parent or student loan debt may be tax-deductible. (You’ll need to file a 1040A or 1040 instead of a 1040EZ in order to take the student loan interest deduction.)

In contrast, the interest on credit card purchases, even when a credit card is used for otherwise deductible educational expenses, can’t be deducted.

To verify your eligibility for any tax benefits on your college loans, consult with a tax advisor or refer to Publication 970 of the IRS, “Tax Benefits for Education,” available on the IRS website.

6) Student Loan Forgiveness Programs

Whereas the only way to escape your current credit card debt is to have it written off in a bankruptcy, several loan forgiveness programs exist that provide partial or total student loan debt relief for eligible borrowers.

Typically, these loan forgiveness programs will pay off some or all of your undergraduate and graduate school loan debt in exchange for a commitment from you to work for a certain number of years in a high-demand or underserved area.

The federal government sponsors the Public Loan Forgiveness Program, which will write off any remaining federal education loan debt you have after you’ve worked for 10 years in a public-service job.

Other federal, state, and private loan forgiveness programs will pay off federal and private student loans for a variety of professionals – veterinarians, nurses, rural doctors, and public attorneys, among others.

Ask your employer and do a Web search for student loan forgiveness programs in your area of specialty.

Consumer Law Report Blasts For-Profit Colleges for Private-Label Student Loans

A new report issued in January by the National Consumer Law Center accuses for-profit colleges of saddling their students with unregulated private-label student loans that force these students into high interest rates, excessive debt, and predatory lending terms that make it difficult for these students to succeed.

The report, entitled “Piling It On: The Growth of Proprietary School Loans and the Consequences for Students,” discusses the boom over the past three years in private student loan programs offered directly by schools rather than by third-party lenders. These institutional loans are offered by so-called “proprietary schools” – for-profit colleges, career schools, and vocational training programs.

Federal vs. Private Education Loans

Most loans for students will be one of two types: government-funded federal student loans, guaranteed and overseen by the U.S. Department of Education; or non-federal private student loans, issued by banks, credit unions, and other private-sector lenders. (Some students may also be able to take advantage of state-funded college loans available in some states for resident students.)

Private student loans, unlike federal undergraduate loans, are credit-based loans, requiring the student borrower to have adequate credit history and income, or else a creditworthy co-signer.

The Beginnings of Proprietary School Loans

Following the financial crisis in 2008 that was spurred, in part, by the lax lending practices that drove the subprime mortgage boom, lenders across all industries instituted more stringent credit requirements for private consumer loans and lines of credit.

Many private student loan companies stopped offering their loans to students who attend for-profit colleges, as these students have historically had weaker credit profiles and higher default rates than students at nonprofit colleges and universities.

These moves made it difficult for proprietary schools to comply with federal financial aid regulations that require colleges and universities to receive at least 10 percent of their revenue from sources other than federal student aid.

To compensate for the withdrawal of private student loan companies from their campuses, some for-profit colleges began to offer proprietary school loans to their students. Proprietary school loans are essentially private-label student loans, issued and funded by the school itself rather than by a third-party lender.

Proprietary Loans as Default Traps

The NCLC report charges that these proprietary school loans contain predatory lending terms, charge high interest rates and large loan origination fees, and have low underwriting standards, which allow students with poor credit histories and insufficient income to borrow significant sums of money that they’re in little position to be able to repay.

In addition, these proprietary loans often require students to make payments while they’re still in school, and the loans can carry very sensitive default provisions. A single late payment can result in a loan default, along with the student’s expulsion from the academic program. Several for-profit schools will withhold transcripts from borrowers whose proprietary loans are in default, making it nearly impossible for these students to resume their studies elsewhere without starting over.

The NCLC report notes that more than half of proprietary college loans go into default and are never repaid.

Recommendations for Reform

Currently, consumers are afforded few protections from proprietary lenders. Proprietary school loans aren’t subject to the federal oversight that regulates credit products originated by most banks and credit unions.

Moreover, some proprietary schools claim that their private student loans aren’t “loans” at all, but rather a form of “consumer financing” – a distinction, NCLC charges, that’s “presumably an effort to evade disclosure requirements such as the federal Truth in Lending Act” as well as a semantic maneuver meant to skirt state banking regulations.

The authors of the NCLC report make a series of recommendations for reforming proprietary school loans. The recommendations advocate for tough federal oversight of both proprietary and private student loans.

Among the NCLC’s favored reforms are requirements that private student loan companies and proprietary lenders adhere to federal truth-in-lending laws; regulations that prohibit proprietary loans from counting toward a school’s required percentage of non-federal revenue; implementing tracking of private and proprietary loan debt and default rates in the National Student Loan Data System, which currently tracks only federal education loans; and centralized oversight to ensure that for-profit schools can’t disguise their true default rates on their private-label student loans.

Other proposed reforms the NCLC supports include modification of federal bankruptcy laws and expansion of federal college loan debt relief programs.

The NCLC argues for a modification of current bankruptcy laws that would allow student borrowers to discharge onerous student loan debts in a bankruptcy petition without having to meet the current, nearly-impossible-to-satisfy “undue hardship” tests. Amidst more relaxed bankruptcy rules and strengthened non-bankruptcy alternatives, the NCLC maintains, fewer borrowers would find themselves hopelessly mired in student loan debt.