Common Sense 101 For Student Loans

Whether you're paying college tuition now or looking forward to that delightful prospect, Uncle Sam is about to give you new options for handling those bills. For years, the federal government has subsidized loans from banks under the Stafford loan program, which will still be available. But the Clinton Administration also wants to make direct student loans. In July, the Administration unveiled its program, which offers easier terms than the government-guaranteed student loans and a wider variety of payment options. The new options permit smaller monthly payments stretched over as many as 30 years, as compared with standard 10-year student loans.

Students can apply for the new plan at 104 schools. Washington hopes that by 1998, 90% of all student loans will be made by the government. Families with teenagers first entering college are eligible, as are the 25 million people who are already paying banks back $60 billion in student loans. Under a plan to be unveiled soon, current borrowers can switch to government loans without penalty. For example, if you have a Stafford loan issued by a bank, you can convert to a government loan with a more lenient repayment schedule.

Administration officials still urge families to dip into their savings to help pay the bills. The cost of a private four-year college averages $90,000 nowadays, and financing the tab exclusively with debt could capsize most family budgets. You don't want to default later on--it will wreck your credit rating, and your pay may be garnisheed. "You have to start early accumulating money for college," advises Leo Kornfeld, the Education Dept.'s Deputy Assistant Secretary for student financial assistance. "For the middle-income family, it's the second major investment behind their homes."

Yet the government's initiative could be especially helpful for people of modest means, such as Marjorie Merimonde, a 47-year-old service technician for Xerox and divorced mother of two. In the fall, her 18-year-old daughter, Jaime, will enter Muhlenberg College, a small liberal arts school in Allentown, Pa., costing $23,000 a year for tuition and room and board. In four years, it will be daughter Jaclyn's turn. Through a patchwork quilt of loans, Jaime is set for her freshman year, but the lure of stretched-out lower payments has Merimonde considering a new scheme for the future. "Let us get through the first year, and we'll worry about the rest later," she says.

If Merimonde chooses a direct government loan, she'll have four options. One would be a 10-year payment schedule identical to the standard bank loans that are still offered. Students pay monthly installments of at least $50. Another choice extends the payment schedule on a sliding scale as the size of the loan increases. A student who borrows less than $10,000, for example, would pay back the money on a 12-year schedule, while a student borrowing $60,000 would pay back over 30 years.

FLEXIBILITY. A third possibility involves a graduated payment arrangement. At the time diplomas are handed out, students would pay relatively little, but payments would increase according to a set schedule based on the assumption that the student's income would rise. (If that doesn't happen, the borrower can switch to an easier repayment plan.) When incomes are modest, the graduates effectively would pay below-market interest rates, but the difference between what they are paying and the market rate would be added to the loan balance. The length of the loans could vary from 12 to 30 years.

The final option pegs monthly payments to income, to be reported to the Education Dept. by the Internal Revenue Service. Details are being ironed out, but under this arrangement, repayments would vary according to a borrower's adjusted gross income. Borrowers can expect to be assessed 3% to 15% of their adjusted incomes, depending on the loan amount. And if the loan isn't paid off after 25 years, the outstanding debt is forgiven.

DRAWBACKS. The Administration's plan is not without downsides. Lower monthly payments and a longer payout period mean paying more over the life of the loan. And stretching out the loan has other drawbacks. Your children could still be saddled with college loan payments even as they're sending their own kids off to school. "The loans will be more flexible," says Ray Loewe, president of Educational Planning Systems Inc., a financial-consulting service in Marlton, N.J. "But the trap is that sooner or later it all catches up with you."

Far and away the greatest source of aid for students and parents are subsidized or unsubsidized Stafford loans. The subsidized loans are available to families of four with incomes of less than $40,000. Under the plan, the government pays the interest on the loan through college and up to six months after graduation. The unsubsidized Stafford loan, which is not subject to income restrictions, starts accruing interest immediately at the one-year Treasury bill rate. In either case, no payments are required until six months after the student graduates. The maximum loan amount over five years is $23,000.

So-called Perkins loans are even more attractive, if you're lucky enough to get one. Loans are dispensed on a first-come, first-serve basis. Eligibility limits are similar to Stafford loans, but interest is only 5% (vs. 7.5% for current Stafford loans) and doesn't accrue until after graduation.

Students who need more than $23,000 may want to explore the federal PLUS loan program. These 10-year loans, which are also offered through some employers, allow parents to borrow 100% of the cost of college, less the amount a student has received from Stafford and Perkins loans and other aid sources. The interest is 3.1 points over the one-year Treasury bill rate. The time you have to pay the debt depends on the amount you borrow: 12 years for a $7,500 loan, say, and 30 years for loans of $60,000 or more.

The financial aid officer at your college can clue you in about private scholarships and grants. You may want to consider a home equity loan, whose interest payments are tax deductible. As a last resort, you could borrow from your 401(k) employee retirement fund, an unwise practice that could deplete your retirement investments.

The best strategy, of course, is to limit your borrowing by saving as much as possible. "Parents need to cut costs and better position themselves," consultant Loewe advises. The key is to start early. You have a wide range of options, but procrastination is not one of them.

      Assuming a student borrowed $17,125 for college at 8% interest, here are the guidelines on how much a subsidized Stafford loan will cost:
      Repayment Plan  Monthly Tab     Total Payments
      10 YEAR             $207        $24,840
      25 YEAR             $132        $39,600
      30 YEAR             $126        $45,360
      Salary Contingent Plan (25 Years)
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