As college costs continue to skyrocket, many parents are planning ahead by saving in a 529 plan or other education savings account.
But what if you can’t afford to save enough to cover the full cost?
One way to close a college savings gap is to use student loans.
If you’ve read the headlines over the last five years or so, you’re probably hesitant to borrow money (or have your child borrow money) for college.
After all, aren’t we in the midst of a student debt crisis?
Don’t worry, not every student who takes out a student loan graduates with excessive debt. When done responsibly, taking out a student loan is a smart way to pay for a college degree.
And, for most students, higher education is well worth the investment.
According to a recent study from the Federal Reserve Bank of New York, college graduates typically earn a salary premium of around 75 percent over the average worker with a high school diploma.
Here are some helpful tips on how to best use student loans so that you can set your child up for future success:
How Much to Borrow in Student Loans
The amount your child should borrow in student loans depends on how much their education will cost and how much you can afford.
As a general rule of thumb, experts recommend aiming to save one-third of future college costs and covering the remaining two-thirds with current income (including scholarships) and student loans.
You also need to consider the price of the college or university your child will attend and their field of study. Another helpful rule of thumb is to keep total student loan debt below the amount of your child’s expected starting salary.
Keeping the balance manageable will help ensure that your child will be able to repay their loan within a standard 10-year repayment term.
For example, if your child chooses to pursue their own paths such as becoming a freelancer or perhaps they choose some lower-paying profession, they should consider a public college instead of a private university.
Types of Student Loans
Students have the option to borrow federal student loans or private student loans.
As the name implies, federal student loans are offered through the U.S. Department of Education. These include Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct Plus Loans.
Direct Subsidized Loans are available to students who demonstrate financial need. They are an attractive option because the U.S. Department of Education pays interest on the loan while the student is in school and during the grace period after they graduate.
Direct Plus Loans are an option for parents of undergraduate students, but interest rates are generally higher than federal loans for students.
Federal student loans offer many benefits, including lower interest rates and more forgiveness and repayment options than private student loans.
Unfortunately, there is a limit to how much you can borrow in student loans. Once those limits are exhausted, students can look into a private student loan.
Private student loans are offered through a bank, credit union, or other lenders. The biggest differences between federal and private student loans are:
- Federal student loans generally have lower interest rates than private student loans
- There is no limit to how much you can borrow with private student loans
- Private student loans typically require a borrower to have good credit and a steady income, or a cosigner that meets these qualifications
How to Apply for Student Loans
Students apply for federal financial aid, which includes federal student loans, by completing the Free Application for Federal Student Aid (FAFSA).
After submitting the FAFSA online, your child will receive financial aid offers, including the amount of federal student loans they are eligible for, from their college.
If your child needs more than the amount of federal student loans that they qualify for, they can explore private student loan options.
It’s important to do your research when it comes to private loans. Interest rates are generally determined by the borrower’s credit score (or their co-signer’s credit score) and can be fixed or variable (fluctuating over time).
Even a difference of half a percentage point of interest can make a big difference in the amount your child ends up paying overtime.
There are free websites that review and rank private student loan lenders where you can get information on interest rates and overall customer service.
Of course, your best bet is to save as much as you can for your child’s future college education.
But, in reality, most students will have to use student loans to fund a portion of the cost.
The key is to teach your child how to borrow smart so that their debt doesn’t become a major financial burden.