By Investment Associate Bobby Adusumilli, CFA.
For many people, going to college is a dream come true. While in college, they grow and evolve as people, meet close friends, and have some of the best times of their lives. College degrees often provide people with the skills and qualifications that they need in order to get the jobs that they want. From an earnings perspective, getting a college degree is an important steppingstone in increasing career earnings as well as improving career opportunities, particularly for people who come from more disadvantaged backgrounds.[1]
And yet, earning a college degree is a real financial burden for a lot of people. As demonstrated below, the total student loan debt in the US reached a record $1.75 trillion in 2021, equating to nearly $38,000 per student who borrows.[2][3] Even 20 years after graduation, roughly half of borrowers still have around $20,000 in student loan debt on average. Student loan debt is even greater for people who pursue master’s or doctorate degrees, sometimes amounting to hundreds of thousands of dollars.[4] The costs of college have been only going up over the past 20 years, meaning student loan debts will remain a major burden for a lot of people throughout their lives.[2]
Source: “Student Loan Debt Statistics”. Melanie Hanson, 01-Mar-2022, educationdata.org.
By understanding and preparing for the benefits as well as costs of higher education options, you can make better higher education decisions for your family for both now and the future. In order to help your family with this, we first detail the different types of student loans and repayment options. Then we provide some actions that both parents and students can consider in efforts to lower the costs of higher education.
Types of Student Loans
If you need to take out student loans, you can borrow from the federal government and / or private lenders. Due to interest rates, qualification criteria, and repayment options, most people tend to borrow from the federal government. As further detailed by the Wall Street Journal, there are four primary types of federal student loans:[4]
Direct Subsidized (Stafford) Loans are available to undergraduates based on their financial needs. As long as you are enrolled in college at least half-time, you don’t begin accruing interest until six months after graduation.
Direct Unsubsidized (Stafford) Loans are available for both undergraduate and graduate students. Undergraduates typically receive lower interest rates. You begin accruing interest as soon as you take out the loan.
Direct Parent PLUS Loans allow parents of undergraduate students to borrow up to the full cost of attendance of the school. Interest begins accruing immediately.
Direct Grad PLUS Loans allow graduate students to borrow up to the full cost of attendance of the school. Interest begins accruing immediately.
In terms of lowest interest rate, the priority tends to be Direct Subsidized (Stafford) Loans, then Direct Unsubsidized (Stafford) Loans, then Direct Grad PLUS Loans, then Direct Parent PLUS Loans.[4]
Some people decide to take out private loans from third-party lenders such as SoFi and Earnest, particularly if they want to consolidate their outstanding loans into one loan in order to potentially take advantage of a lower interest rate. However, private loans are usually subject to more stringent rules, and you may need to spend more time monitoring private loans in order to keep taking advantage of lower interest rates.
Student Loan Repayment Options
While your future finances may be uncertain, we believe that choosing and sticking with a repayment plan can help you both pay off your student loans quicker as well as better plan other aspects of their finances. Private loans typically have strict criteria and scheduled repayments. Federal student loans usually provide borrowers with more flexibility. As further detailed by the Wall Street Journal, here are some ways that you can choose to repay federal student loans:[4]
The Standard Repayment Plan allows you to pay a fixed monthly amount with the goal of paying off the loan in 10 years. You are automatically enrolled in this plan, though you can choose a different repayment plan.
The Graduated Repayment Plan starts out with lower monthly payments and increases them about every two years, with the goal of paying off the loan within 10 years. This option may make sense if you expect your income to steadily increase.
The Extended Repayment Plan allows you to pay either a fixed or steadily increasing monthly amount over 25 years. You must have at least $30,000 in federal loans to qualify.
The Revised Pay as You Earn (REPAYE) Repayment Plan sets monthly payments at 10% of your discretionary income, which the US government calculates based on income and family size. The balance is forgiven after around 20-25 years.
The Pay As You Earn (PAYE) Repayment Plan sets monthly payments at 10% of your discretionary income. The balance is forgiven after around 20 years.
The Income-Based Repayment Plan sets monthly payments at 10% to 15% of your discretionary income. The balance is forgiven after around 20-25 years.
The Income-Contingent Repayment Plan sets monthly payments at the lower of 20% of your discretionary income or the amount you would pay on a fixed 12-year repayment plan. The balance is forgiven after around 25 years.
Under Public Service Loan Forgiveness, you must work for a nonprofit or government agency for 10 years, after which the loans would be forgiven. However, this plan is subject to strict rules, and the vast majority of people have not qualified in the past, though eligibility may expand in the years to come.[6]
The Loan Simulator for the US Department of Education allows you to compare what you would pay over time under the various repayment options.
When evaluating which repayment option best suits your situation, we generally recommend to pay off your student loans as fast as reasonably possible. Interest adds up over time, and debt can be a psychological burden. Additionally, we do not believe that people should expect the US government to further forgive federal student loans. By paying off student loans quicker, you can allow yourself to focus on other parts of your financial life, such as raising a family and preparing for retirement.
Helping Your Child Prepare For Higher Education Costs
Especially for parents who have time to help their child prepare for higher education, you can consider the following:
Apply for financial aid: While each school has different eligibility criteria, many schools offer needs-based financial aid as well as merit-based scholarships to eligible students. In order to determine whether you qualify, you should complete both the FAFSA form as well as the CSS Profile.
Apply for private scholarships: Many private organizations offer both needs-based as well as merit-based scholarships to students. While each organization has a different application process, you can ask your school counselor for organizations that other students have received private scholarships from. In addition, you can check out the websites Scholarships.com, Cappex, Scholly, and Going Merry.
Invest in a 529 account: 529 accounts are state-sponsored investment plans that allow people to save and invest after-tax money, with the gains being tax-free so long as the proceeds are used for qualified education expenses for the beneficiary. Additionally, many states offer state tax deductions for contributions to a 529 plan. You can find more information about 529 plans on the Saving for College website.
Analyze the costs and prospects of college options with your child: Each college has different costs, financial aid, scholarship criteria, and median career earnings prospects. By reviewing the various college and financial options with your child, you can increase their understanding of both the benefits and costs of the school that they ultimately choose. The College Navigator tool can help you compare the costs of colleges compared to people who are in a similar financial situation as you. For students who qualify for financial aid, the College Financing Plan is a standardized form provided by most colleges to help students understand and compare the expected college costs. The College Scorecard from the US Department of Education allows you to compare earnings and debt data for different degrees across various colleges.
If you want to loan your child money for school, set up a repayment plan: In order to help their children with student loans, many parents decide to loan their children some of the money for college, often with a low interest rate and more flexible repayment timeline. For parents who do this, we often recommend for you to create a promissory note to be signed by both you and your child that details the student loan repayment terms and schedule.
Higher education can be transformative for students, but it is important to recognize the costs of higher education. As you and your child are evaluating higher education options, we can provide resources, experience, and strategies that may be valuable to you. Please feel free to reach out to us if you have any questions or would like to talk through anything.
Important Disclosure Information & Sources:
[1] “How Big is the Racial Wealth Gap?“ Nick Maggiulli, 02-Jun-2020, ofdollarsanddata.com.
[2] “Student Loan Debt Statistics”. Melanie Hanson, 01-Mar-2022, educationdata.org.
[3] “Average Student Loan Debt”. Melanie Hanson, 10-Jul-2021, educationdata.org.
[4] “The WSJ Guide to Student Loans“. Wall Street Journal, 2022, wsjplus.com.
[5] “Consumer Price Index for All Urban Consumers: Tuition, Other School Fees, and Childcare in U.S. City Average“. Federal Reserve Bank of St. Louis, 2021, fred.stlouisfed.org.
[6] “Public-Service Loan ‘Forgiveness’: Answers to Common Questions“. Cheryl Winokur Munk, 03-Dec-2021, wsj.com.
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