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Billionaire investor Robert Smith announced in his commencement address he would pay off all of the student loan debt of the entire graduating class at Morehouse College.

The Many Benefits of Student Loans

Prudent borrowing can ease the cost of college.

Hopefully all of the horror news stories about spiraling student loan debt will keep your clients’ families from borrowing too much money to pay for a too-expensive higher education.

But those nightmare scenarios may also irrationally scare clients away from using what can be an effective tool to pay for a reasonably priced college degree. Here are five reasons clients should consider using (certain) student loans to pay for (a portion) of college costs.

Borrow big dollars, pay back smaller ones

Very few people would expect to save money to pay cash for a house. By the time they accumulated enough to cover the purchase price, they would be ready for the nursing home.

Paying for higher education should be viewed in the same light, especially when it comes to working and saving, versus borrowing and enrolling.

Let’s say that instead of borrowing $30,000 for higher education expenses, the student chooses to work and use her earnings to cover that amount. According to Bureau of Labor statistics, the median hourly wage of full-time U.S. workers aged 16 to 24 was about $12.50 for females, and $13.65 for males. Assuming she would make $13 per hour, she would have to work about 2,300 hours to raise that $30,000 amount. That’s full time for 13 months and doesn’t include taxes or living expenses she would incur.

On the other hand, suppose she borrows that $30,000 and by the time she graduates interest has grown the amount to, say, $35,000. The National Association of Colleges and Employers said that in 2018, new college graduates working full time had an average starting salary of $50,004, or about $25 per hour. At an interest rate of 6%, she would then need only 1,600 hours of post-graduate gross earnings to repay that $35,000 of college debt within five years of graduation—and she would still have the vast majority of her earnings left over to pay for living expenses.  

Easy approval process

One of the many advantages that federal student loans have over private education loans (and just about all other types of borrowing) is that there is no traditional credit check or income verification required of the borrower. Instead, the would-be borrower must first fill out and submit the FAFSA federal financial aid form, complete a counseling course to help him understand the terms of his loan and then sign a Master Promissory Note agreeing to the loan terms.

Clients who want or need to borrow money for higher education should start with the federal loans, of which there are three main types: 1) Direct Subsidized Federal Loans are available to undergraduates who demonstrate financial need and have more friendly interest-accrual terms (see below); 2) Direct Unsubsidized Federal Loans are available to undergraduates regardless of need but begin racking up interest costs as soon as the money is borrowed; and 3) Direct PLUS Loans are available to graduate or professional students, or parents of dependent undergraduate students. Direct PLUS Loan requirements are a little more stringent, but still not as bad as most other traditional loans. No minimum credit score is required for approval, but the parent borrower can’t have an “adverse credit history.” The Department of Education defines this status as being more than 90 days behind on payments of debts totaling more than $2,085, or having such events as a bankruptcy, debt discharge or tax lien incurred in the previous two years.

Of interest     

College loans are not only relatively easy to obtain, the cost of the debt is also much lower than other types of similar loans. For the 2018-2019 school year, Direct Federal Loan interest rates were 5.05% for undergraduate students and 6.06% for grad students. The best rates on private student loans are in this ballpark but can be much higher—depending on the borrower’s credit standing and whether the borrower chooses a fixed- or variable-rate loan.

Whether the student loan is public or private, going forward up to $2,500 of the interest can be tax-deductible each year, as long as the borrower meets certain criteria. First, the interest has to be charged to a loan for which the taxpayer is personally responsible; i.e., parents can deduct the interest on parent loans, and students can deduct the interest on student-originated loans. Second, the borrower can’t file as “married filing separately”—only single, married filing jointly, or head of household filers are eligible. Finally, the deductible amount can be reduced in part or in full, depending on the borrower’s modified adjusted gross income (MAGI). Last but certainly not least, the student loan interest tax break is an “above the line” deduction, meaning that taxpayers don’t have to itemize to benefit from the deduction.

Delayed interest

Borrowers who qualify for need-based Direct Subsidized Federal Loans (in an amount determined by the school) don’t begin accruing interest on the borrowed money as long as they are enrolled at least half-time. Even after they leave school, there is a six-month “grace period” during which interest isn’t charged. Once the six months are up, the interest begins to accumulate on the debt. This feature can save the borrower thousands of dollars over the four (or five, or more) years that the student is in college.

Reducing and deferring payments

Most federal student loans (and some private versions) offer eligible borrowers the chance to temporarily reduce or postpone repayment, without the lender immediately declaring that the borrower has defaulted on the loan. But, this option is only a temporary break from making loan payments. Depending on the borrower’s situation and the type of loan, interest may continue to accrue to the loan even if the payments due are reduced or deferred.

Borrowers of private loans should contact their lender to see if they are eligible to reduce or defer payments. Federal student loan borrowers can visit studentaid.ed.gov. Federal student loan borrowers may also qualify for one of several income-based loan repayment plans that cap payment amounts as a percentage of income. Depending on the plan, after 20 or 25 years any outstanding loan amount can be forgiven. Find out more at www.ibrinfo.org.

Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster). 

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