Fed loans best option, even at twice the price

Stafford rate could double by July; still best deal

May 13, 2012 @ 12:01 am

By Liz Skinner

Although the 3.4% federal student loan rate will double if Congress doesn't act soon, financial advisers still argue that government loans are a better choice than most other debt options for financing a college education.

If, by July 1, Congress doesn't renew the rate on new Stafford loans for another year, it will automatically climb to 6.8%, causing interest expense to rise by about $1,000 a year, on average, for the 7.4 million students who typically take out these loans every year, according to the White House.

Although Democrats and Republicans agree on extending the lower rate, they disagree on where to find the $6 billion needed to pay for it.

In the Senate last week, Republicans blocked efforts to continue debate on a Democratic bill that would fund extension of the 3.4% loan rate by closing what supporters called a “loophole” that allows certain S corporations to avoid paying some Social Security and Medicare taxes.


On the other side of the political aisle, the GOP-controlled House passed a bill last month that would fund the loan program by diverting funds from preventive health care, but the White House maintains that President Barack Obama won't sign such a measure.

“It's crunch time for Congress,” Sen. Jack Reed, D-R.I., told reporters at the Capitol on Tuesday. “Both parties have to work together to find a fair and rational way of keeping the student loan interest rate in check.”

The issue takes on more urgency at a time when American students and their parents are already struggling with soaring higher-education costs and about $1 trillion in education debt.

Benjamin Tobias, president of Tobias Financial Advisors Inc., said that if the rate were allowed to rise to 6.8%, the financial impact would be dwarfed by the damage done to the lives and careers of young people forced to give up their college dreams.

“We've seen kids not going to college already, because of the high cost of college,” he said.

But most advisers said that even at 6.8%, the rates and terms of student federal loans still would be superior to other financing options for college. They recommend that clients accept all offers of federal loans.

The loans are advantageous for several reasons: The government pays the interest while the student is still in school, borrowers can receive income-based repayment options, and loans are canceled in the case of death.

After accounting for funds specifically saved for college and taking out federal loans, advisers who specialize in education funding usually recommend private student loans or that parents seek home equity loans.

However, with nearly one in four U.S. homeowners owing more on their mortgage than their home is worth, private loans are sometimes the only option. Luckily, these products have improved, according to advisers.

Since the federal government took over being the direct lender on federally backed loans in 2010, private student loans are offering lower rates and better terms, said Harvey Meldrum, founder of Meldrum Financial LLC.

“Commercial banks have had to get more competitive in terms of rates and features,” he said.

The major private-loan providers, including Sallie Mae and Wells Fargo & Co., now offer fixed-rate student loans, which are an improvement over variable-rate loans, said Mark Kantrowitz, publisher of FinAid.org, a college grant and loan website.

Private lenders are offering rates that are often lower than Parent PLUS loans, which the government offers to parents at a rate of 7.9%, he said.

However, parents' credit scores must be very high to get the best rates — 5% or less, Mr. Kantrowitz said.

Private loans are in the student's name, cautioned Fred Amrein, president of Amrein Financial. Even if the parent is the co-signer, the first responsibility for repaying the loan falls to the student, he said.

“These fixed-rate private loans can be a good deal for some borrowers,” Mr. Kantrowitz said.

The new Consumer Financial Protection Board is examining the private-student-loans market and is due to weigh in with its recommendations in a July report to Congress. The report may address whether people who have student loans should be allowed to discharge them through bankruptcy, which would require congressional action.

One new student lender, Social Finance Inc., offers rates more favorable than the government's PLUS loans and fixed-rate private loans, and matches many of the benefits of the federal student loans, including income-based repayment options.

SoFi raises money from alumni of certain colleges that is pooled to fund loans for students of that college. Alumni of Stanford University's Graduate School of Business have lent about $2 million to students for the 2011-12 academic year.

SoFi said alumni will get a 5% return on their investments.

The company said it plans to offer $150 million in new loans at 40 schools for the 2012-13 school year.



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