MERIT-BASED AND NEED-BASED FINANCIAL AID MADE SIMPLE

Merit and need-based aid are the two major types of college funding that do not require repayment. Understanding the difference between them can save a family time and money, and help with college selection. This knowledge also helps a family save on the cost of college. As you know, we have been reviewing and discussing three aspects of creating a college funding program: saving for, shopping for, and saving on the cost of college. Saving for college employs a combination of 529 accounts, taxable accounts in the parents’ and/or child’s name.

Shopping for a college means finding the right fit academically, socially, and financially. Parts of the social and academic apply to the financial side. For example, a student’s GPA and test scores may help qualify him or her for a scholarship. The social component may have added costs, such as fraternity or sorority dues. Other types of clubs may be free. A family must also know how much it can afford to pay before the child attends a higher education institution. In performing this first task, feel free to download my college funding snapshot report. This report offers insights into the current funding status of the student’s higher education.

Saving on the cost of college means understanding the resources beyond savings that you can use to create price breaks. We typically call this bargain hunting or smart shopping to ensure you do not overpay. For example, while looking for deals online, you likely have come across a promotional code to receive a discount on a product or service. Perhaps while buying your last vehicle you received a rebate or 0% financing. You should pursue saving on the cost of college with the same vigor and skills. One way to create a price break for college, as mentioned before, involves merit. A second way to create a price break bridges shopping for college by strategically applying to universities with favorable need-based practices.

Understanding Merit-Based vs Need-Based Financial Aid

 

What is merit-based financial aid?

Merit-based aid is money based on something other than financial need. We often hear about sports or academic scholarships. For the latter, students must commonly maintain a minimum GPA. To qualify for the academic scholarship, the student must typically have met certain academic standards. An example may be a school that gives an automatic scholarship to students who earn a minimum SAT/ACT score with a certain GPA upon high school graduation. Other times, students must write essays or participate in civic activities or interviews. For more prominent universities, the student may have to provide a combination of all these.

As the definition suggests, merit-based money may be awarded for many types of actions. When considering merit aid, a family must be aware of a few things. If the scholarship is private, is it a one-time payout? How much effort will the student be exhausting for the scholarship? For example, if two scholarships are under consideration and require equal amounts of effort, students should apply for the higher payout. For multiyear scholarships, what standards must be met? If the student does not finish his or her degree or meet the standards, will the student be required to pay it back? Families may want to consider scholarships that “prepare” a student for the college application, which may require an essay. Specifically, does the scholarship essay ask the student to state what makes him or her different and the best fit? The student may be able to use this material later for the application essay. Make changes to fit the specific need; the more the student tells his or her personal story, the stronger his or her confidence will become and the more easily he or she will be able to tell the story in the future. This also creates efficiencies in the application process for other scholarships and college applications.

Merit aid may come packaged in a few ways. The first is a competitive scholarship. Here, students compete against one another in a range of areas, including interviews and essays. The second merit aid is more like a grid of test scores and GPA. If you earn a certain score and graduate from high school with a certain GPA, you may receive the funds automatically. Following is the merit scholarship from Miami University.

The last form of merit aid is a package from the university. Here, the student may receive funds based on a combination of factors, like extracurricular activities, interviews, GPA, and test scores.

A merit-based conversation would not be complete without a discussion of sports scholarships. I left these out for two reasons. First, many parents expect their children to receive some type of aid if the student was a better player on his or her sports team. However, the numbers don’t bear this out. Eight million high school athletes compete each year in the United States. Only 480,000 of those athletes will compete on a collegiate level (1.). That means roughly 1 in 16 high school athletes will compete at this higher level. Further, only 150,000 students in Division I and II schools receive athletic scholarship offers. Even then, they may not be full rides, leaving parents and students with some out-of-pocket costs. Division III schools do not give out athletic scholarships. However, it is not uncommon for a small group of student-athletes to receive some other type of merit-based aid.

What is need-based financial aid?

Need-based financial aid reflects the student’s and family’s ability to pay tuition. This does not stem from anything other than financial need. The driver for need-based aid directly reflects the basis college funding formula.

Cost of attendance – Expected Family Contribution (EFC) = Need

If you recall from my other article outlining the EFC, this is what the government thinks your family may pay based on the student’s income and assets as well as the parents’ income and assets. Typically, the largest driver in the EFC is parental income. Decreasing the EFC is one way a family can try to increase need. A second and often overlooked alternative involves increasing the cost of attendance. Typically, this involves bringing out-of-state state schools and private schools into the picture for consideration. On a side note, more out-of-state schools are offering in-state tuition prices for neighboring states. For example, I learned that several Ohio universities, both private and public, were offering in-state tuition to incoming Indiana students. A later blog post will provide more details about this pricing reciprocity.

Remember, you are trying to get the lowest net price possible. Combining the EFC and attendance strategies may be another option. However, most upper-middle-income families do not consider these tactics because they do not fill out the FAFSA or CSS, which also serves as an application for many school-based grants and scholarships.

Understanding merit-based and need-based aid does not stop here. Families must also understand the differences between institutional and private scholarships

Private and Institutional Scholarships

One of my favorite activities is fly fishing. Admittedly, I am not good, but the simple act of casting a line over moving water with a smooth movement of the rod back and forth is beautiful. I make a few special trips each year to earmarked locations simply to engage in this activity. The experience creates the proverbial fishing stories we hear, tell, and share with friends. In my case, though, I can count on one hand the number of fish I have caught with a fly rod.

What does this have to do with scholarships? It seems that families have the same experience with scholarships. We hear and share stores about the “big money” given to the boss’ nephew’s daughter, or maybe our student even gets a few scholarships himself or herself. Often, it will be a few one-time hits for a few hundred to a couple thousand dollars from a specific nonacademic source, like a community foundation or business. These nonacademic sources provide private scholarships.

Institutional scholarships are given through the big players, like universities and the government. In fact, undergrads receive a much higher dollar amount from institutional money than from private scholarships.

I make this point not to say that private and employer-based grants are not important, but rather to explain where the large pool of money sits. Back to the fishing analogy. If I want to catch several fish, I should stop using my fly rod and instead fish with a stick of dynamite. Families may gain more aid money for their efforts if they refocus on where the large pool of money sits.

An important side note: If your family plans to use a college financial aid company or individual, make sure you understand what they are providing. Last year I attended a seminar that promised to get my daughter scholarships and get her into “great institutions.” However, the burden of the work for getting the scholarship still rests on the student’s shoulders; the aid company may simply screen for scholarships for which they suggest the student apply. The student must still write the essay. Some free sites match the student and the scholarship opportunity. Many of the best opportunities come from specific scholarships at the school. When you are shopping for schools, it is a good idea to ask about grants and aid at the university and department levels.

Merit vs. Need Tendencies

Colleges often favor one form of merit or need-based financial aid. Knowing how your prospective school favors aid will help you create a college funding strategy. Let’s take a look at two examples.

The University of Notre Dame has 100% of financial need met, with 79% of the funds coming from scholarships and grants and the remaining 21% coming from loans and/or jobs. Miami University meets only 59% of a student’s financial need, with 59% coming from scholarships and grants and 41% coming from loans and/or jobs.

In a nutshell, Notre Dame focuses more on meeting the student’s financial need while Miami seems to focus on the grid system. Does this make Notre Dame better? No; the two universities simply take a different approach to scholarships.

How do I take advantage of need-based or merit-based financial aid?

Hopefully, you have picked up on the fact that most schools lean one way or the other in dispensing financial aid to students. Families should become familiar with where the schools on their list lie. The best way to perform this task is to lay out a grid for the student as a means of understanding where to focus.

It is not enough to say that a school leans more toward merit or need aid; after all, the student will be the one attending school. A family’s best aid option does not lie on a clear path. Rather, a continuum exists. Income shows the point. The parent’s income will most likely be the biggest driver in controlling the Expected Family Contribution or EFC. We know families make $0 to millions.

The continuum exists on the GPA and test side of merit aid. There is no pass/fail.

The best way to understand where a school sits is to create a grid style of analysis, like the one below.

Start by asking, “Where does the student fall on the chart?”

Are you high need and high merit (quadrant II)? Or maybe low need and low merit (quadrant III)? This will in large part determine the tactics you can leverage to help with your college funding.

An example

Let’s imagine we have two students, Jonny and Suzy. Suzy was diligent in keeping a high GPA, was part of the band, and joined a few clubs to round out her extracurricular activities. She also scored well on her SAT. Jonny was not as active and did not keep a high GPA, nor did he score well on the ACT or SAT. As you can see, we have a high-merit student and a low-merit student.

Let’s further assume that Suzy was raised by a single parent who worked three jobs to make ends meet. Jonny’s parents work in middle management at the local Fortune 500 company, making at least $100,000 each.

Now we know where each student lies. Suzy will be in quadrant II as a high-need and high-merit student. Jonny will be in quadrant III as a low-need and lower merit student.

What comes next?

Each student should continue plotting his or her list of schools on the graph. Do the schools meet a high percentage of need? What about merit? Students should take note of the schools located in their quadrant. While acceptance is not guaranteed, these schools will likely be the easiest for the student financially.

While we have clearly divided the graph into quadrants for discussion purposes, a fuzzy divider exists as you move from one quadrant to another. Students and families must ask the following two questions:

– Which factors move the student around in the quadrant the most?

– Which levers must we pull to get us closer to the school we want?

The first question identifies those factors on which a family may work to improve its college funding plan. The second question introduces action the family can take to move the student to a better position relative to the school.

Let’s get back to Johnny and Suzy.

With Johnny being in quadrant III, he can focus on selecting a favorable school, getting a higher test score, and receiving “tax scholarships.” The latter point means using the tax code to find funds that help pay for school. The two most common examples are the state tax benefits provided by contributing to a 529 and the American Opportunity Tax Credit (if the parents qualify.) Selecting favorable schools means paying more attention to the choice of in-state vs. out-of-state and public vs. private. Price will be a bigger factor. The last component, higher test scores, helps the student work on merit. Not all scholarships are given to high-merit students, but higher test scores help as the university seeks to bring in the best freshman class it can; test scores are a key ingredient for creating a great incoming class.

Suzy, being in quadrant II, has many alternatives. High need means focusing on those schools that meet a large percent of the need. If Suzy and her mom can get the Expected Family Contribution down even lower, her need increases. Lowering their EFC may be another way of helping with college funding. Merit money based on GPA and test scores open the door to those schools that provide merit-based aid. Working on her test prep to gain a few extra points on the SAT/ACT may mean thousands of additional dollars in institutional aid.

The small difference each student makes in his or her plan can yield larger cumulative savings and cost reduction.

Have questions about where to start your college funding plan? Download the College Funding Snapshot Report and watch the video on how to effectively use it.

Sources

1.http://www.ncaa.org/about/resources/research/probability-competing-beyond-high-school

– https://meritscholarships.nd.edu/

– http://miamioh.edu/admission/merit-grid/

TUITION RECIPROCITY AGREEMENTS: THE UNSPOKEN WAY TO SAVE

Tuition reciprocity agreements are one way to cut the cost of higher education while broadening the student’s list of potential colleges. In this article, we will talk about what tuition reciprocity is, the difference between reciprocity and out-of-state scholarships, the major pacts, and requirements.

Use of these pacts is only one way to save on the cost of college. We have also discussed understanding the difference between universities tilt on merit or need-based add as a way to reduce the cost of college. Families should also be saving for college as early as they can. Knowing how to save on the cost of college may bring some expensive institutions in line through the use of reciprocity agreements.

What is tuition reciprocity?

Tuition reciprocity is when a state agrees with another state to provide lower tuition for residents from the other state (and vice versa). Three types of programs exist. The first involves regions of the country from which multiple states join. The second involves a smaller number of states and may include as few as two states. The third involves agreements made between counties, which often share a state border.

For some schools, reciprocity ensures that students outside the normal demographic will consider them. Many of these institutions find it easier to piggyback off each other rather than create new departments. For example, if an Ohio college does not offer a teaching degree but a college in a bordering state does, they may offer pricing reciprocity. You can easily see how this program becomes worthwhile for students.

How are out-of-state tuition scholarships different from reciprocity programs?

As noted earlier, price reciprocity in large part depends on whether you are from a participating state. Indiana students applying to certain colleges in Ohio or maybe Kentucky may receive reciprocity. A student from California wanting to attend the same institution with the same profile would not qualify for the reciprocity price discount.

On the other hand, universities may be willing to give out-of-state scholarships to students who will be traveling farthest to attend. Part of the reasoning stems from the fact that they want more diversity. For example, in the case of an Ohio college, there will likely be a bigger difference between a California high school student and the school’s existing student body than between an Indiana high school student and the school’s existing student body.

Regional reciprocity compacts

Western Undergraduate Exchange WUE states: Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming.

Academic Common Market member states: Alabama, Arkansas, Delaware, Georgia, Kentucky, Louisiana, Maryland, Mississippi, Oklahoma, South Carolina, Tennessee, Virginia, and West Virginia. Texas, Florida, and North Carolina participate only through their graduate programs.

Midwestern Higher Education Compact member states: Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, and Wisconsin.

New England Board of Higher Education. The 82 public colleges and universities in the following six states participate in the tuition discount program: Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont.

Requirements of colleges participating in reciprocity pacts

The requirements to take advantage of such programs typically include maintaining a certain GPA. It is not uncommon that students must maintain permanent residency in the state from which the student is applying. Another common need is to apply for reciprocity separately at the same time the college application is being filled out. For more information about specific schools, check out the pacts noted above.

These pacts are not universal. In fact, not all colleges join them. Do not forget the reasoning we discussed earlier regarding why a school would participate in such an agreement. Larger, more popular institutions likely have so much brand recognition, they do not have to offer a price discount.

Downfalls of reciprocity pacts

An article by Jake at In-stateangels.com notes several pitfalls students and families must consider while evaluating these pacts.

– Major Restrictions- Not all majors are available at participating schools. For those students who are unsure or will likely change majors, the loss of the discount could be devastating.

– High Achievers- As mentioned earlier, a minimum GPA may be required. Jake’s article notes Kansas State University’s requirement of a 3.52 GPA and an ACT minimum of 24.

– Limited Seats- Not everyone who applies will get the discount. Universities do not publish the number of students they will accept under these programs.

– Not Automatic- Make sure you ask the recruiter if you must complete an extra application for the discount. This will vary by school.

– Not Forever- Most students do not graduate in four years. Most of these programs are good for only four years. This may become a costly effort for those unwilling to take on several credits each semester or attend summer school to graduate on time.

Next step

First, download the free College Funding Snapshot to see how much college your family can afford. This information will indicate whether a school participating in a reciprocity pact is worth exploring.

Do you have more questions? Feel free to contact me at ncarmany@thewatermarkgrp.com.

HOW TO PICK A COLLEGE: 6 Factors to Help

Can you imagine wanting a car and heading to the dealership located close to where you typically park, then seeking acceptance from your friends and family for your purchase? This seems like a ridiculous way to buy a car, yet this is exactly how most families approach higher education. Most families select a college based on location and flash when other important factors should drive the selection.

As college consumers, we must change the way we approach higher education. Families must save for, shop for, and save on the cost of college. So far in our series, we have talked about saving and covered information about shopping for college. Saving for college means starting as soon as you can. Accounts like the 529, custodial accounts, and taxable brokerage accounts in the parent’s name help satisfy the saving portion. As we know, shopping for college occurs when the student is close to the age of 18 and means developing a budget so you know how much you and your student can spend on higher education.

Shopping for a school also means knowing the best fit for the student socially, academically, and financially. These are important characteristics because they will ensure a better fit, thereby resulting in more happiness and satisfaction and a lower cost. However, many families don’t properly consider these characteristics, which results in longer academic careers, higher costs because of the extended time at school, lower satisfaction, and missed income from the student not working.

How we pick a college

Most students choose a college that is within a few-hour drive from home. When families tour colleges, the larger names spend large amounts of money to create a warm, glowing front. Admissions counselors tour the state or region, attending college fairs to attract the next freshman class. We can’t forget about sports; how often do we hear a university’s name for the first time during a sporting event? Think about the NCAA basketball tournament and the big names – and the “Cinderella” teams that rarely take part. The point is, the flash mentioned earlier is all around; reputation is a big factor in choosing a college. The reputation may be for academics, research, sports, or partying.

For those families that do a little more research, popular rankings like the US News and World Report one become a common tool. However, the question remains: Do these rankings correlate with success and better well-being after college? In a 2012 blog post (link to the post), a popular college admissions expert, Lynn O’Shaughnessy, notes: “Unfortunately, the methodology fueling the rankings are a collection of subjective measurements that students and families are supposed to rely upon to pinpoint the schools doing the best job of educating undergraduates. U.S. News relies on proxies for educational quality, but these proxies are dubious at best.”

She goes on to note four ways in which the rankings hurt students and parents.

– Rankings encourage the college to favor well-off students.

– Rankings encourage admissions tricks.

– Rankings encourage cheating.

– Rankings encourage debt.

Breakthrough

Over the past few years, researchers have made breakthroughs that can help families make better college selections. Two research powerhouses, Gallup and Purdue University, developed an index. The two institutions joined forces to “respond to increased accountability among higher education institutions… (to provide) insight in the relationship between the college experience and whether college graduates have great jobs and lives.”

After all, isn’t this what we really want for our children? As parents, in selecting a college, we lose the forest for the trees; we get bogged down by the “flash” of an institution and overemphasize unimportant characteristics such as the school’s reputation or sticker price (not to be confused with the price that families end up paying).

How did Purdue and Gallup help?

The Gallup-Purdue Index was the result of interviews of more than 30,000 college graduates from all over the nation. From research already completed by Gallup, we know that having a good job is an important factor in life (1-p1.), as it provides a mean of establishing one’s self-identity. The study focused on the well-being of the interviewees.

Well-being, according to Gallup, builds on five elements (1-p2.).

Purpose Well-Being: Liking what you do each day and being motivated to achieve your goals

Social Well-Being: Having strong and supportive relationships and love in your life

Financial Well-Being: Effectively managing your economic life to reduce stress and increase security

Community Well-Being: The sense of engagement you have with the areas where you live, liking where you live, and feeling safe and having pride in your community

Physical Well-Being: Having good health and enough energy to perform one’s daily tasks

As mentioned before, 30,000 college graduates from many types of colleges and universities were interviewed.

Factors in choosing a college

The study produced interesting findings. Whether a college was public or private, large or small, selective or not – none of these traits mattered more in terms of well-being or work life than the worker’s experience in college. Among the study’s other important aspects was the revelation of six factors that lead to increased well-being (1-p4.).

  1. When a student feels like a professor cares about them as a person.

  2. Having a professor who makes a student feel excited about learning.

  3. Having a professor who encourages students to follow their dreams.

  4. Having an internship or job where the student applies what they were learning in the classroom.

  5. Involvement in extracurricular activities and organizations.

  6. Working on projects that took a semester or more to complete.

The higher the number of these factors students experience in college, the greater their engagement and the likelihood that they maintain overall well-being.

Factors vs. traditional college selection

As you can see from the traditional way we select colleges versus the use of a factor-based approach, the student will likely end up in a better situation in the long run. The process for college selection evolves to become more objective or straightforward. However, a factor-based approach does not mean the student will graduate without debt or will not experience any of the questionable practices of a higher education institution.

Rather, using a factor-based approach helps a family and student identify the key characteristics to look for in a college as tours and research accumulate. The student should also start by answering the following questions: Do I want a small or large institution? Do I want an institution focusing on faculty research or undergrads? Are sports important me? How far away from home am I willing to go? Do I want a technical or liberal arts education? These questions will help narrow the focus and achieve the best fit for the student.

Where can I find information related to these factors?

Ratemyprofessor.com– Here you can find information about specific professors based on the student’s perspective. Here is a snapshot of Ball State University on the university level. Notice the clubs and opportunity ranking. This may help you make evaluations based on factors four, five, and six listed above.

Niche.com– This site also grades a university, according to the categories shown below. The professor rating helps with evaluating factors one and two. While not isolated, this still gives prospective students something to consider.

 

Collegedata.com– Hidden among the data is a section under the Students tab called “After Graduation.” Here, the viewer will see a percentage of graduates who have a job offer within six months of graduation. When looking at placement data, one should keep two items in mind. First, data can be manipulated. This was hinted at earlier in Lynn’s article, and the Hechinger Report covers this topic in more detail. (http://hechingerreport.org/placement-rates-data-colleges-provide-consumers-often-alternative-facts/). Second, majors affect placement rates.

 

College-bound next steps

  1. Work on answering the questions posed about the type of institution first.
  2. Compose your list of schools.
  3. Use the resources listed here to help compare the universities based on the Gallup-Purdue Index.
  4. Find out how much you can afford to pay for college.

Do you like this article? Please share it with other families that might find it useful.

Want more? Subscribe to follow this blog or check out my YouTube channel: https://www.youtube.com/channel/UCgYzBd7iIdkFdwyosJLG–A?view_as=subscriber

Sources

  1. 2014 Gallup-Purdue Index Report
  2. http://www.thecollegesolution.com/how-u-s-news-college-rankings-hurt-you/ (access 1/12/15)

SAVE FOR COLLEGE OR RETIREMENT? WHAT YOU’RE NOT TOLD

Paying for college has been the theme of this important series using a three-prong approach. First is saving for college using accounts like the 529. If you have seen any recent news on the topic, you likely have a fundamental understanding of how this account works. This step also uses other savings vehicles. The second prong is to shop for colleges that fit your needs financially, socially, and academically.

Today’s article addresses perhaps the biggest question that influences families that are college shopping: Do I fund my child’s education or my retirement? The extent to which a parent favors one answer over another drives the family’s ability to pay for college. The last step we will explore involves saving on the cost of college.

We will review the issue of funding college versus funding retirement, why it is important and the standard industry advice. Ironically, the standard falls short in helping families answer this question. Inherit problems will be highlighted with the standard advice. We will wrap up the article with examples that demonstrate why saving for retirement first may be a bad idea. As always, you should check with your team of professional advisors to see how any of the concepts, terms, or ideas apply to your situation.

Why is funding college versus retirement such an important question?

Middle-class families live on limited incomes. A middle-class family must decide what to do with these incoming dollars. Do they save or spend the funds? If they spend, what do they buy? On the flip side, for which goal does the family save? Even knowing which goal should take the top priority, the family must make decisions about which vehicle (stocks, bonds, CDs, etc.) and account (Roth, IRA, taxable, 401k, 529, etc.) to use.

Several studies on American savings and habits clearly explain the stress we experience in our financial lives. With goals that cost millions (like retirement) or $100,000 or more (like college), is it any surprise that we stress about finances? It isn’t that families plan to fail in meeting their goals; instead, they fail to plan. To meet our goals, we must face the pain of discipline now; otherwise, we will face the consequences later. With limited income and expensive goals, where does a family save extra dollars?

Standard industry advice

The financial services industry tells families to save for retirement first. After this goal is met, the family can save for college. The language most families hear is something along the lines of “You can’t borrow for retirement, but kids can borrow for college.” Let’s look at a few examples from popular financial resources.

The article from Howstuffworks.com titled “The Kids’ College Funds Can Wait. Save for Retirement First” makes several points about why parents should save for retirement first.

– As previously mentioned, there are no loans for retirement.

– Working later because you funded your child’s education isn’t a plan. Forces outside our control – like a job loss or disability – can spoil our plans.

– You may be doing a disservice to your children if they end up supporting an elderly parent. While you may have paid $100,000 for their education, you did not save the $300,000 or more required to take care of yourself. Your child may end up footing the bill.

– Roth IRAs are a reasonable vehicle for college and retirement savings.

Consider the points from a Vanguard blog post, “Save for Retirement and College.” Here, the author suggests that you prioritize retirement before any other goal. “First and foremost, pay your future self. Unlike college, you can’t take a loan for retirement.” Second place on the priority list should be paying down debt, followed by a rainy-day fund. Saving for college should take fourth place, according to this author.

Carrie Schwab-Pomerantz also chimes in on the subject in a post called “Saving for College: Understanding Your Options.” Here, Carrie answers a question from a mother who is wondering about saving for college for her three-year-old child. College costs and savings vehicle information is shared. Carrie states:

“As parents, it’s natural to want to put our children’s needs first. But you can use loans to pay for your child’s education if you have to. You can’t get a loan for retirement. So, as important as college is, our retirement should always come first. Think of it as another way of taking care of our children, by ensuring we’re financially independent once we’re no longer working.”

The last financial guru, Dave Ramsey, leads his followers in “Retirement of College Funding: Which Comes First?” by asking “What is more important—my own security at retirement or my child’s education and future? There’s a lot of emotion wrapped up in that question, which makes it easy to come to the wrong conclusion.” Simply put, in his “Baby Steps,” Dave prioritizes retirement over college for a reason. “You’ll depend on your retirement savings to live, eat, and pay for shelter—the basics. If you’re not working, that money is your only source of income.”

Are you convinced?

With the industry gurus taking the same side of the coin, it seems pretty convincing that saving for retirement should be a priority over saving for college. I was part of this crowd for years until my oldest daughter entered her sophomore year of high school. I started looking at data and noticed these articles, which pointed towards studies in which parents took money out of their retirement accounts to pay for college. The data and studies were verified.

However, two items started making me question this advice. First, I hadn’t read an article with any numbers that stated why saving for retirement over college was better. Second, I started understanding why parents pull money out of retirement accounts to help pay for college. I’m not advocating this as a smart move, but rather acknowledging an understanding of behavior. I’m in the same situation as the middle-class parents. Advice from high-income earners (likely many of the financial gurus noted above) seems to make the subject a little less relatable from an emotional standpoint. We parent, live, and make choices emotionally.

Contrarian standard

In 2015, Mark Kantrowitz, a financial aid expert, wrote an article for Time.com called “Saving for College vs. Saving for Retirement: Why the Conventional Wisdom is Wrong.” Mark did the calculations and reviewed a couple of scenarios while dispelling financial planning myths.

– You can’t take out loans for retirement. Simply put, a couple over the age of 62 who has adequate home equity may take out a reverse mortgage or reverse equity line of credit.

– In fact, borrowing money to pay for college was a bad idea. Check out the article for the data. (Exploring it in detail here would make this article too long.)

Does it ever make sense to borrow money to pay for college?

Mark’s article highlights a specific situation. “The only time borrowing for college costs is financially beneficial is when the interest rates on parent loans are lower than the equivalent long-term earnings rate on your investments. But that just doesn’t happen very often.”

Currently, Direct PLUS loans carry an interest rate of 7%. Most financial plans assume rates of return of between 5%-6.5% depending on the portfolio, planner, and timeline.

Why does the financial services industry tell parents to save for retirement first?

To start, there’s a conflict. As I noted in my Current State of Affairs post, most advisors earn a commission for selling a product or they receive compensation from the assets they manage. Few charge by the hour or charge a flat fee. These same people and institutions will help families look for ways to fund goals that don’t take money away from the generation of revenue. Looking at the conflict another way, college will be coming before retirement and is less expensive. From the advisor’s perspective, the parent or student should take out a loan. The goal is funded and the advisor isn’t paid less. The loan will be dealt with later.

Next, outside of a few individuals, the industry doesn’t know how college funding works. Savings, loans, scholarships, work-study programs, class hours taken – these all influence the cost of college. Few if any discussions or works are available about how to shop for college. Families must match the student with the best college from the beginning; this can reduce time in school and transfers, the latter of which increases costs.

The reality is that parents will likely be on the hook for at least some of the student loan debt if they haven’t saved. The federal government will allow only $27,000 in student loan debt over four years with Stafford loans ($31,000 between subsidized and unsubsidized). The rest will come from either PLUS loans, private loans, or home equity. PLUS loans require a parent to participate, and private loans usually require a cosigner. This, again, places the matter back in the parent’s lap. The solution is to make college funding part of a family’s plan to shop for and save on higher education.

How many advisors and financial service professionals work in the trenches?

Based on my experience, very few (specifically, doing things like helping families fill out the FAFSA). Personally, I enjoy volunteering twice a year at College Goal Sunday. Families bring in their information and we walk through the FAFSA. No selling, just helping kids get into school and giving information to Mom and Dad.

Beyond the conflict and lack of understanding of college funding, the industry forgets that financial planning has value to the end client only when the plan is based on the client’s own values, not what we impose on the client. If a family ranks college funding over retirement, the advisor has the responsibility to build the plan that way AND to educate the family about the tradeoff between funding college and/or retirement. With more information, the parent better understands his or her choice and the cost of his or her decision.

What do you do?

– Take a deep breath. As a parent, I want the best that I can give my children. If that means working longer or having a little less at retirement, fine. I understand the choice and cost of this decision. Most parents have the same mindset of giving the best they can to their kids. To save for retirement over college seems contrary to how we parent and makes some parents feel as though they are being selfish.

Put your advisor through the paces and see how clear the college funding portion of your plan is. If it only states saving $x’s/month, you may be in trouble. Have a young child? Your advisor must, at a minimum, use a process or method to help beyond the savings component.

– If your student is in high school, use these articles to help you understand college funding. Download this worksheet to develop a college funding snapshot. This will help you understand how much the family can afford today.

Have more questions? Call to schedule a time for us to talk at 317-805-0840.

HOW TO PAY OFF STUDENT LOANS

If you have been following this series of blog posts, you know that college funding is the focus. The process, while easy on the surface, requires three steps. First, save for the cost of college. Many sources – from bloggers to financial publications – discuss this topic, and large financial institutions tell you how to save for college. The second step, shopping for colleges, has been the focus of the last two blog posts, which reviewed trends in college funding and how to pay using the different types of student loans. We continue with the second step of the discussion: paying back student loans. The last step will help you save on the cost of college.

First Student Loan Conversation

As a Certified Financial Planner, I was not aware that dealing with student loans would become a common planning topic in the same way that planners now help Boomers with Social Security planning. I became aware of this need only a few years ago. In 2010, I had my first conversation that shaped the way I see this crisis.

The son of a client came into my office with his new bride to talk about cash flow and getting his new life off to a great start. We talked about many of the normal things young couples desire: a nice home with a family, vacations, and cars. There were miles of smiles around the table as the conversation progressed.

Then I asked about income and jobs so that we could focus on making these dreams a reality. The conversation quickly came to a halt. The wife had just begun her first job and had a student loan that was large but workable. The husband sat quietly in his chair while the wife and I discussed the details of her income, student loans, and job. Noticing that he was uncomfortable, I asked the husband what was on his mind. He revealed that his student loan debt totaled just over $100,000. He did not work and was not confident that his liberal arts degree would allow for the lifestyle we had discussed.

This conversation drew my attention to the effect student loans can have on a young person’s life. Unfortunately, my professional life took me in another direction. I did not return to this negative reality until six years later, when we started college planning for my oldest daughter. This brings us to the important question.

What is the best strategy to pay back student loans?

Google the term “strategies to pay back student loans” and a plethora of articles will pop up discussing everything from making more than your minimum payments to refinancing your loans to taking on a job that provides forgiveness. While these methods have worked for some people, I subscribe to the keep-it-simple mentality.

Two strategies have proven successful among families that face a large amount of debt. Dave Ramsey created one of the popular strategies, called the Debt Snowball. This is by far my favorite strategy because it acknowledges the power of behavior. The strategy is simple.

  1. List all your debts on a piece of paper, from the lowest dollar amount at the top to the highest dollar amount at the bottom.
  2. Write out the minimum payment next to the loan balance.
  3. Make the minimum payment on all the debts except for the one with the lowest balance.
  4. Pay as much as you possibly can toward the lowest-balance debt. Before you know it, the debt will be gone.
  5. Scratch the debt off your list and start over. Make the minimum payments on all the debt except for the new one with the lowest balance. Again, pay aggressively on this balance until it is gone.

With this strategy, momentum builds quickly because of the quick victory in paying off a few of the lower balances. The student loan borrower will see that getting out of debt is possible and will not feel as overwhelmed. The downside is that this is not the optimal strategy financially. You may pay more interest because the highest-interest loan may not have the lowest balance. In my opinion, though, through the creation of a momentum-building sequence, the debt holder will stick with the strategy, thereby yielding better results.

Interest Optimization

The second strategy takes a similar approach but instead of listing the loans by balance, you list them by interest rate, with the highest on top. As with the Debt Snowball, you make the minimum payments on all loans with lower rates and pay aggressively on the high-interest rate. While this creates an optimal financial outcome, the average debt holder has a hard time creating momentum. The strategy is best suited for those who easily understand how debt and compounding work.

The other strategies that you would see in a Google search typically involve one-off actions like refinancing. You may lower your interest rate, but did you extend the term of the loan or give up other provisions by moving away from federal loans? Taking a job that provides forgiveness may translate to lower take-home pay. Think about the difference in pay when working for the government or a company.

Spending Plan

You may have noticed that both strategies require “paying aggressively” toward one of the loans. This means creating margin in your monthly cash flow. How do you do this? First, you avoid using the word “budget.” This word interrupts financial progress. People associate budgets with micromanaging and doing without.

Creating a spending plan means balancing those things that are most important to you while creating the margin to put toward your student loan debt. You do not have to focus on where every dollar goes; rather, consider whether each purchase creates the highest level of happiness for you or your family.

Two methods can be used to create my favorite style of spending plan. The simple versus may be completed using four different-colored highlighters and your bank statement. The second method requires more effort or a spreadsheet. For purposes of the conversation today, the simple version will be the focus.

Simple Spending Plan Instructions

First, pull out your bank statement and use four highlighters, each for a different category: highly important, moderately important, could do without, and savings. Next, decide what goes into each bucket. Third, total the amounts for each category. Fourth, figure the percent of total spending for each category.

The goal is to create margin in your financial life. Savings should account for 12-30% of your income, while highly important and moderately important should account for the rest of your spending. If, for example, you encounter a lack of savings, you must prioritize your spending so that the lower, can-do-without expenditures can be moved to the savings category. For example, is living in your current place important to you, or is it the features/characteristics that you like? If the latter is the case, find a cheaper way to get those features and characteristics. The goal is to start looking at your spending in ways that promote the important facets of your life. Work with the number until you meet the 15-30% threshold. Slowly work on getting the can-do-without cash flows off your bank statement, then move the cash flow into a savings vehicle that starts increasing your savings bucket. Once you have the cash flow straight, a small amount of savings will likely have accumulated; you can use this to pay down student loan debt or, more importantly, act as an emergency fund. Now you will move the cash flow that built your savings to aggressively pay down the debt.

Student Loan Refinancing

Having followed the exercises above, you have created a margin in your monthly cash flow and know which debts to aggressively pay down first. Next may come the question of whether you should refinance or restructure your student loans. Exercise caution when addressing this topic and consider the following points.

– Beware of income-based repayment plans and their true long-term cost. You are trading dollars today and tomorrow for much later.

– If your plan is to simply find a job after school, you could be missing out on opportunities for student loan forgiveness. This may change, but states also offer student loan forgiveness programs. Reference the other article I have already written.

– When consolidating federal loans into a private loan, you may be giving up the following: income-based repayment options, access to student loan forgiveness programs, and forbearance and deferment options.

Wrap-Up

A payback strategy is great; start small and work on building momentum. Use the technique above to build your emergency fund. Once you check off these two items, you can address the next common hurdle that many parents face.

Should parents of teenagers save for college or retirement? Even younger millennials try to answer this question with their young children. Keep an eye out for the next article, which examines this dilemma.

 

STUDENT LOAN TRENDS

The last article focused on step two of the college funding process. It reviewed the types of student loans and broke them down into federal and private loans, as well as the subcategories of student and parent loans. Today, we continue by discussing student loans and the student loan crisis. Will there be a crisis or is it already here? What trends are taking place with student loans?

Funding College with Student Loans

Seven out of ten families will use some form of student loans to help pay for college. Many families accept this statistic as a normal part of sending a student to school. Some families see the current debt load of $1.4 trillion and focus on creating a lower or no-debt funding plan. The goal for later families is to help control early expense risk (increasing needed cash flow to duties that do not normally exist). With few or no student loans, young workers can save for retirement, a house, a baby, or other goals.

Problems do exist for students who have student loans and no degree. A worker with a college degree earns more over a lifetime than does a person without one. Imagine how much further behind a college drop will be when student loan payments enter the equation. Not only will this person earn less, but his or her expenses will increase.

Government Limiting Risk

As strange as it sounds, we can thank the government in some way for helping limit the expense risk that students face – specifically, those students who did not earn degrees. You may recall from the post Different Types of Student Loans that the federal government limits how much a student can borrow based on his or her year. Freshmen can borrow $5500, sophomores can borrow $6500, and juniors and seniors can borrow $7500. The caps limit risk by not letting underclassmen take out too much in federal student loans.

These limits make sense when one considers the high number of students who drop out of school. In risk management, this would be an example of risk reduction. The student’s risk of default does not go away but rather is limited to the lower amount of the Stafford loan. In terms of other types of student loans, this trend moves in the opposite direction. A quick review of the data below shows the point.

Notice the 25% growth in Parent PLUS loans and the almost doubling of the nonfederal loans? These are the loans that start getting families in trouble, which begs the question: How does this happen after more than a decade? After sitting by some of the families and helping them fill out their FAFSA forms this fall, I have no doubt that the process of going to college creates large amounts of stress for the student and the parent. Many feel that completing the FAFSA is not only harder but more stressful than completing their tax return.

When families receive their acceptance letters and aid packages, the sense of relief overcomes them and they pay little attention to the financial aid package. As consumers, we must keep in mind that these non-friendly loans become collateralized with Mom and Dad’s names or assets. Bankruptcy does not necessarily dismiss the debt, either.

Here we sit, in $1.4 trillion of student loan debt.

Student Loan Crisis

When do you call something a crisis? Is it after we push the ball off the cliff, or just before the tipping point of going over the cliff? Experts disagree on the answer, and some contend that a crisis does not exist. However, we cannot dispute the data. The following graph shows a different story (1.)

Nearly one-third of the federal education loan portfolio is in deferment, forbearance, or default. Not all delayed payments under these programs are negative. A student may qualify for a deferment for several reasons, like active duty, military service related to a war, a military operation, a national emergency, or enrollment in an approved rehabilitation training program for the disabled (2.). Other scenarios may qualify a person for deferment.

Simply looking at the default rate should make us uncomfortable. Mortgage delinquencies during the great recession topped out at 10.53% (3.). We are sitting at nearly the same rate on student loans. The public keeps sloughing off the concern. Major ramifications will likely result if the default rate continues increasing, which may drag on for some time. As mentioned before, student loans typically cannot be written off in a bankruptcy. Banks wrote off the bad mortgages from the Great Recession. For capital markets to work efficiently, this write-off process should be short. The markets then quickly adjusted to reprice the mortgage. The default of a student loan has the potential to go on for years or maybe decades as long as the borrower remains alive. Markets cannot be efficient with the current state of affairs, and inevitably delays the likely result of not recovering the principal amount of the loan.

Possible Crisis Scenarios

You know from my other posts that student loans have a negative effect on the individual. For example, when families have student loans, they save less for retirement and delay having children. Blow this effect up nationally and imagine how things change. The question to answer is: How do student loans with extended defaults affect spending and economic patterns?

What if it was easier to declare bankruptcy on student loans?

Perhaps the financial markets would be able to absorb the disruption more quickly than forcing a delay and extended process for dismissing the debt. Of course, the normal and negative side effects would accompany the dismissal. The family/individual would be able to move forward more quickly. Today, the issue is politicized, with no progress made in terms of reform or in the ability to dismiss the debt. The courts still use a standard – called the Brunner test – established in 1987 (4.).

Even debt holders using income-based-repayment plans face some economic challenges. By dragging out payments over 20 or 25 years, the worker pays more interest, which is not going toward other desired outcomes that contribute to current or future economic output. To put it another way, more dollars are spent on the past than on the present or future.

The current system has produced no significant changes. As mentioned before, debt has increased at a ridiculous rate. A rising interest rate environment creates a squeamish outlook for students who take out future loans and for those who hold variable rate loans.

Perhaps a different form of “forgiveness” should be reviewed, or we should let the markets help decide the fate of delinquent loans.

Next Step:

If your student is college bound, take the first step and create a college funding budget. Consider it the rudder on a ship; it will provide direction and prevent your student from facing the student loan crisis problems that this post has outlined. Second, create a smart lending strategy. This means knowing the rough starting salary of your career. The student should not graduate with more in debt than his or her first year’s salary. Shop for a school that meets the needs of your student socially, academically, and financially.

For those in school, take the time now to estimate the debt you will have accumulated upon graduation. Will you be eating ramen noodles or living the way you expect? If the former, make changes now to limit the damage. Take on a shift at a local business or at school. Do not borrow money for spring break trips. Take more credit hours or go to summer school so that you do not extend your academic career by another year or two.

Before your student heads off to college, make sure you know how much you can afford by using the free College Funding Snapshot Report.

Have questions? Call me at 317-805-0840 or email me at ncarmany@thewatermarkgrp.com.

Sources:

  1. Trends in Higher Education Series. PowerPoint. 30, October 2017.
  2. https://studentaid.ed.gov/sa/repay-loans/deferment-forbearance#deferment-eligibility
  3. https://fred.stlouisfed.org/series/DRSFRMACBS

http://www.studentloanborrowerassistance.org/bankruptcy/

RESOURCES TO PAY FOR COLLEGE

In the last blog post, The Current Reality of Paying for College, we discussed the nature of college funding, the misalignment between the financial services industry and parents, and how we parent. Specifically, we examined the details behind the Student Loan Bubble and compared default rates to the mortgage delinquencies of 2008. The numbers show that the student loan bubble is already here. For those with current student loans, a new mindset must lead the way in creating innovations that minimize interest paid over the loan’s lifetime. Families with college-bound students must focus on how they save for, shop for, and save on the cost of college. This blog post reviews the first of three steps in saving and shopping for college, as well as the cost involved.

Before we dive into the specifics, we must ask a question.

How do families currently approach college funding?

A new trend worth noting shows that an all-time-high number of parents are saving for college: 72 percent according to a recent Fidelity survey (1.) Seventy-six percent of the respondents are very or somewhat familiar with the popular 529 account. The survey discusses three knowledge gaps: 1) how much a family should be saving and the future cost of college; 2) understanding the fundamentals of 529 accounts; and 3) how saving for college affects financial aid eligibility (1.)

The last point of the study deserves clarification. The study mentions having grandparents help save for college but doesn’t describe how to do this. If money is gifted to parents who then put the funds into a 529, then yes, there is minimal impact on the FAFSA funding formula. However, if grandparents put the funds directly into the 529, then pay the school from the account, major implications may affect financial aid during the student’s following school year. Up to 50 percent of the money distributed from the grandparents’ 529s may be taken away in need-based aid. This is where working with a fee-only financial planner may help.

Increased savings will benefit college-bound students. However, as noted in the three gaps from the Fidelity survey, understanding the cost of college is important. Financial aid trends in grants, loans, and tax credits play another important role in financing higher education.

College Funding Sources: Loans

The following bar chart highlights the difference in federally subsidized loans on the funding percent from the 96-97 school year to the 16-17 school year (2.). This funding source was cut by more than 50 percent. By comparison, notice the large increases in federal unsubsidized, Parent PLUS, Grad PLUS, and nonfederal loans.

The increases are worth noting because of the large financial strain they put on students and parents. In my other blog post, you can see the result of this strain. As further proof of the difficulty in servicing these large increases in student loan debt, take a look at the following chart (2) showing deferment, forbearance, and default. Keep in mind that filing bankruptcy on student loans is difficult.

https://trends.collegeboard.org/student-aid/figures-tables/repayment-status-federal-education-loan-portfolio

 

Is easy access to money partially to blame for this increase in student loan debt? It seems that little regard is given to students’ ability to service the debt beyond graduation. This comment does not dismiss consumer responsibility but rather acknowledges the behavioral aspect of shopping for college from a consumer point of view.

How we shop matters.

How we shop matters to the point that financial institutions limit how much we can borrow. Imagine going to the Ferrari dealership as a fresh college grad making $45,000 a year and applying for a car loan. What would a bank tell a young couple trying to buy $1,000,000 on an income of $75,000? Of course, the bank will say no. In fact, the bank will pre-approve you for an amount so you know the maximum price range in which you can shop.

Wise and informed consumers will have a much lower self-imposed limit and will shop around for the best bargain. Why do lenders limit the amount you can borrow? The lender must limit the risk associated with your total debt load, which makes credit scores, income, and assets part of a standard review before one borrows money for a major buy. These debts can typically be claimed as part of a bankruptcy.

Student loans have much lower standards for borrowing money. Over their undergrad years, all students qualify for up to $27,000 in Stafford loans with no questions asked and no credit check. Parent PLUS loans do require a credit check but there is no total limit on the loans. Private loans vary, but I meet people coming out of college with hundreds of thousands in student loan debt. Can you blame the student loan lender for these low standards? As mentioned earlier, it affects the student and, likely, the parent.

As consumers, we must treat the college shopping experience the same way a bank imposes limits on how much one can borrow for a home. Also, we do not buy the first home we see. Instead, we look for homes that meet our needs at a great price. Valuing the education from one institution may be similar to the way in which we value both market aspects and personal preference in pricing a home.

College Funding Sources

There are five broad personal funding sources: parent resources, parent loans, student resources, student loans, and other help. Scholarships and grants may pay for college, but the family does not have control over whether the money is awarded.

Parent resources include both income and assets collected for college. Here are a few examples: 529s in the parents’ name, taxable brokerage accounts, Roth IRAs in which the money was saved specifically for college, monthly cash flow (kids do not live with parents for free and may cost $250-$300/month), tax credits (for example, the Annual American Opportunity Tax Credit), 529 state tax credit, and public matching programs like Upromise or the Hancock County Promise in Indiana.

Parent loans typically include Parent PLUS and private student loans as the two most common ways for parents to borrow money to pay for college. A third possibility includes taking out a home equity loan. If you are a parent over the age of 62, a reverse mortgage may be another avenue to examine. (Please consult with your financial advisor to review how these may or may not fit your needs.)

Student resources include income and assets similarly to parents’ assets. Many of the same types of accounts apply but with a few differences. Taxable accounts are referred to as UTMA or UGMA accounts, and the parents typically decide about the funds. If monthly cash flow exists, it likely comes from a part-time job. Parents usually claim the tax credits while the child attends college (normally, the child remains a dependent for an undergrad degree). Do not forget that these assets weigh heavily in determining the expected family contribution (how much the government thinks you can pay for college).

Student loans start with Stafford loans, then move into private loans. When a student enters the private loan market, usually a co-signer must be on the loan. Make sure all parties understand the loan’s covenants. Students often get in trouble because they do not understand how the debt works after graduation or if they drop out of school.

The last category covers all other sources of funding. Grandparents gifting money to mom, dad, or grandchild and 529s saved in the grandparent’s name are the two most common funding vehicles in this category. Families must be aware of how this category may affect any financial aid the student receives.

A good college funding budget would look similar to the example below.

One final important detail must be addressed. Notice the First Year Salary and Student Loans sections. These numbers should help set the maximum student loan debt a graduate should accumulate after leaving college. For every $10,000 in student loan debt, you should expect roughly a $100 payment for 10 years. Because not all majors produce the same level of income, the student should accumulate the appropriate level of debt.

Next Steps:

  1. Gather your tax return, W2s, and asset statements.
  2. If you do it yourself, work with your student to create a college funding budget.
  3. Work with an advisor? Schedule a meeting with you, the student, and the advisor to walk through this college funding worksheet.
  4. If you need help, contact me at ncarmany@thewatermarkgrp.com or call 317-805-8040 to schedule a time for us to walk through your college funding budget.

 

Sources:

1.  https://www.fidelity.com/about-fidelity/individual-investing/families-underestimating-future-college-costs   
2. https://www.fidelity.com/about-fidelity/individual-investing/families-underestimating-future-college-costs

3.https://trends.collegeboard.org/student-aid/figures-tables/repayment-status-federal-education-loan-portfolio

 

DIFFERENT TYPES OF STUDENT LOANS

A great college funding plan considers the different types of student loans and has three steps. The first step sets up your resources and budget. The last blog post focused on this topic. We reviewed how to create a college funding budget and compared it to the pre-approval process of buying a home. Also, the post explored the different funding categories. Loans made up two of those categories – one for parents and one for students. The second step in your college funding plan creates a smart lending strategy so the student or parent does not create a future financial burden. The last step is to shop for college. We will study this topic in later posts.

Today, we focus on the second step by examining the different types of student loans. As mentioned in other works, there are two major categories of student loans: federal loans and private loans. Each category may break down further into student or parent loans. Student loans refer to debt that is in only the student’s name. Parent loans may be in the student’s name but the parent acts as a co-signer, or the loan may be in only the parent’s name.

FEDERAL LOANS

Stafford loans are the most common type of federal student loan. These loans will be either subsidized or unsubsidized. Among the loans, three differences exist: 1. The government pays the interest on subsidized loans while the student attends college. 2. The eligible amounts for subsidized loans are lower than those for unsubsidized. 3. A student must qualify for the subsidized loan, while every undergrad student is eligible for the unsubsidized loan. The student qualifies for subsidized loans by demonstrating financial need. To put it in a simple math formula (1.):

Cost of Attendance – Expected Family Contribution = Demonstrated Need

As you saw in my other post about expected family contribution, calculating this number is anything but easy. However, from the formula above, you get the basic of idea of how to qualify for subsidized Stafford loans. The government manages the amount it will cover in loan interest by limiting the amount of the subsidized loan. Depending on the amounts, a student may borrow the following under a subsidized loan: $3,500 for freshmen, $4,500 for sophomores, and $5,500 for juniors and seniors.

As mentioned earlier, every student qualifies for unsubsidized loans. The dollar amount a student may borrow depends on the grade level: $5,500 for freshmen, $6,500 for sophomores, and $7,500 for juniors and seniors. With this type of loan, the interest starts accumulating at the loan’s origination.

The two types of loans may be used together but the amount borrowed in any one year should not exceed the higher limit of the unsubsidized loan. If a student qualifies for subsidized loans, this will be used to the maximum first; then an unsubsidized loan will be added to the amount and not exceed the limit. Interest rates are fixed for the life of the loan and reset for new loans every year.

Perkins loans are another type of student loan that may be used. They are low-interest loans for grad and undergrad students who demonstrate exceptional financial need. The school is the lender and payments are made to the school or its service provider. Not all schools participate in the Perkins loan program, and funds may be limited (2.) Students with a high need should check with the school’s financial aid department for participation details. This loan program is not as popular as Stafford loans.

Parent PLUS

Parents may help students pay for college using a Parent PLUS loan. Parents of PLUS loans may acquire loans for dependent undergraduate loans (3.) These loans are not accessible to other students, namely graduate and independent students. Divorced parents may both acquire loans, but the total between them cannot exceed the loan limits (3.)

The total amount that parents may borrow for any one year follows the formula below:

Full annual cost of attendance – other financial aid the student received = Potential PLUS loan

Parent PLUS loans require no debt-to-income ratios and are not dependent on the borrower’s credit score (3.) As a result, the interest rates on these loans are rather steep. The current interest rate for the 2017-2018 academic year is seven percent with a 4.264% origination fee, making the real first-year rate for the loan 11.264%. As you can see, this high rate can quickly put families in trouble. Now just imagine the problems faced by families that take out these loans year after year.

Repayment of the loans typically starts 60 days after the loans are fully dispersed (3.) However, loans after July 1, 2008, can be deferred while the student attends school at least half-time (3.) The standard repayment applies to a 10-year repayment schedule. Income-based repayment schedules typically cannot be used with Parent PLUS loans, but they are eligible for student loan forgiveness (3.) PLUS loan consolidation cannot be done with other federal loans in the student’s name.

To apply for PLUS loans, parents fill out the FAFSA, then request the loan through StudentLoans.gov. You can also contact the financial aid department of the student’s college or university.

Private Loans

Private student loans vary greatly in terms, payment provisions, and features. For the most part, private loans lack many of the common features of federal loans, like fixed interest rates and income-based repayment plans, and are not subsidized (if you qualify). Most private student loans are issued by banks, credit unions, state agencies, or even the schools themselves.

Many private loans require repayment while the student attends college. Some of these loans require an established credit history or a co-signer (often the parent). Student loans commonly use variable rates. If interest rates rise, the loans become more expensive. Additionally, the loan may not be consolidated into a Direct Consolidation Loan and it may not have forbearance or deferment options.

In general, private loans do not compete with the flexibility or features of most federal loans. However, private loans constitute one of the fastest growing types of loans. See the graph below.

 

As noted above, the federal government limits the amount a student may borrow in Stafford loans. The price of tuition continues to rise year after year. As a result, programs like Parent PLUS and private student loans experience large growth.

Summary

Many graduates to wonder how they will pay back their complicate and confusing student loans. As we saw, student loans divided into federal and private loans and further split into parent and student-only loans. Federal loans give the borrower attractive terms as compared to private loans in general.

Student loans are the focus of the second step in creating a smart college funding plan. The student and family should know how much they can afford if the college budget is established up front, thus reducing the number of surprises upon graduation.

Coming Up

The next post discusses paying back student loans. It starts with a smart lending strategy.

 

Sources:

  1. https://www.edvisors.com/fafsa/estimate-aid/financial-need/
  2. https://studentaid.ed.gov/sa/types/loans/perkins
  3. https://www.edvisors.com/college-loans/federal/parent-plus/introduction-to-federal-parent-plus-loans/

Navigate The Stock Market Volatility

 

Stock Market Volatility

1. with the recent price swings you be getting a little scared of the markets and wonder if another 2008 is upon us.
2. we do not know for sure but let’s review a few a things.
– The large point drop in the DOW of nearly 1600 points was large at 6.26% but not the largest in percentage terms
on 8/24/15 the dow saw a 1089 point drop or 6.6%
– 5/6/2010 saw the flash crash with the DOW Dropping over 9%.
POINT: it is not the down days that define the success of an investor. It is staying in for the good days. I.e. remove the top 10-20 days and things really do start looking bad, but you need to stay invested.
– On average we see in an intra-year drop from peak to trough of 13.8%.

2. It is your stock/Bond/Cash ratio that best explains your return and volatility over time at over 90%.
– If you were extremely nervous perhaps we need to have a conversation about your capacity for risk and risk perception.
– It may be time to change your longer-term allocation.

3. We use a disciplined approach to match your portfolio to your goals. Accomplishing your goals is really what this is all about any.
– Matching your investment portfolio to your goals.
– How to use a bucketing methodology.

We use an academic approach to factor-based investing
The premiums:
1. Stocks outperform bonds over time.
2. Small-cap stocks outperform large-cap stocks over time.
3. Value stocks outperform growth stocks over time.
4. Profitable stocks outperform stocks with low profits over time.

529 Accounts and Tax Reform

In this video, we talk about the recent tax reform, 529 accounts, and how it may not be as great over the short term as people hope.

Topics:
1. Provision of the tax from allowing families to withdraw $10,000 for private tuition.
2. Tax treatment of 529 on the federal and state level.
3. States playing catch-up to the tax reform.

As always, check out collegeandretirementplan.com for more information or email me at ncarmany@thewatermarkgrp.com.