a learning experience
Most of my young clients join the ranks of the professional world with some level of student debt. It's this very reason that any family with a student getting ready for college or graduate studies should read on.
Recently, I took on a client who came to me with $168,000 in total student debt. To make following the story easier we will give my client a fictitious name and call her Anne.
Anne obtained her PharmD at a private institution and therefore graduated with a substantial amount of debt. Her level of debt isn't unlike most young adults without wealthy parents to pay the astronomical cost of tuition. The point is, had Anne or her parents come to me prior to the borrowing stage, we could have saved Anne well over $100,000 on her student loans!
So where did my client go wrong?
Anne borrowed $97,000 of her $168,000 from private lenders -- namely, Sallie Mae and Wells Fargo. Yes, Sallie Mae is a private lender. Unfortunately, too many borrowers assume Sallie Mae is a part of the Federal lending program. The confusion is that up until 2014, Sallie Mae used to be the loan service provider for two Federal loan programs: the William D. Ford Federal Direct Loan Program and Federal Family Education Loan (FFEL) Program. Since October 13, 2014, Sallie Mae split into two companies and the part that services Federal loans became Navient.
Unfortunately, what I have learned from analyzing so many client student loan plans is that most borrowers do not understand the terms and conditions of their loans. Nor do they know the proper channels to follow before choosing a private lender. These are fundamental problems that result in the average person potentially getting taken to the cleaners.
What are the proper channels to borrow student debt?
For most families, borrowing might be the only option. In order to help aid in that decision process, use the following hierarchy when borrowing at the undergraduate level (best to worst):
- Perkins Loans - $5,500/year
- Direct Subsidized - $5,500/year
- Direct Unsubsidized - $20,500/year (less any subsidized amount received)
- Parent PLUS Loans
- Private Loans - Fixed Rate
- Private Loans - Variable Rate
Now for those looking for higher learning opportunities at the graduate level, like my client, Anne, Federal loans should be the first choice. The common misconception is that a grad student can only borrow $20,500 per year from the Federal program, with a lifetime limit of $138,500. This is true with the Direct Unsubsidized program, however, the Graduate PLUS program allows a student to borrow up to the cost of attendance (minus any financial aid received).
Therefore, it is entirely possible to pay 100% of the cost of tuition with Federal loans. In order to qualify for the Graduate PLUS program, a student must have sound creditworthiness. So for students with bad credit, they may need a parent to guarantee the loan and co-sign. Assuming that parent trusts and understands their credit is tied to their child, the Federal program remains a better alternative to borrowing from a private lender.
Some parents prefer to see their kids have some skin in the game and pay for a portion or all of the cost of college. Or, at least make their kid think they have to pay for their education until that student has earned their degree. Therefore, the bank of mom and dad is always the place to start for those who are more fortunate than others. However, that parent or grandparent should review the minimum personal loan rates published by the IRS so that they do not inadvertently get hit with a gift transfer tax.
How does private debt have anything to do with saving More Than $100,000 on student loans?
It just so happens that Anne works for a hospital that is classified as a non-profit (501.c.3). Student loan borrowers working for a 501.c.3 are currently eligible for a government debt forgiveness program called, Public Service Loan Forgiveness (PSLF). In order for a public employee's loans to qualify for debt forgiveness, the following criteria must be met:
- Full-time public sector job (30 hours or more)
- Direct Federal loans only
- Loan status is repayment
- Cumulative of 120 on-time payments
- Payments made from an income-driven repayment plan -- IBR, PAYE, REPAYE
The key criteria missing for Anne was that her Federal debt only amounted to $72,000, which is still a lot. However, when compared to her annual income of $109,000 it wasn't. Basically, the higher ratio of income-to-debt greatly reduced Anne's level of forgiveness. In fact, she gets a marginal benefit compared to a standard 10-year payment plan -- only $350 of forgiveness was projected in our analysis.
On the other hand, had Anne borrowed everything from the Grad PLUS program, her total Federal debt would have exceeded her annual income. This is when PSLF and other types of debt forgiveness offer a substantial financial benefit to the borrower. In Anne's case, she would have benefited from a projected savings of $116,700. Instead, we had to go a more conventional route and refinance a majority of Anne's student debt. This meant her total estimated savings was reduced to $22,600.
This is not an area of your life to give the old college try
The impact of student debt borrowing decisions and how to pay for college, even at the beginning stages, is substantial. For my client, Anne, we are talking about a difference of $94,100. It's why college planning is essential for families with college-bound kids. Especially when that kid wants to pursue a higher cost degree like a doctor, lawyer, veterinarian, or pharmacist. Regardless, the economics of making sound choices will dramatically affect your child's adult life. So if you are a parent or young professional and don't know or don't have the time to learn it, enlisting the help of an expert is worth every penny.