The U.S. has a lot of debt. The consumer-driven economy is pushing people into bankruptcy. The average household owes more than $10,000 in high-interest credit card debt on six or more cards, and the government just said that our national savings rate is negative. (Not that the government has anything to say about it; it spends so much more than it brings in that the new exciting goal in Washington is just to cut the deficit in half by the end of the decade.)
In this sea of splurging spending, where people have sold their homes to pay off credit cards, only to max out those same cards in the same year, it is strange that the American people don't want to borrow money through the Stafford loan programme to pay for college. In fact, the same students who sign up for card after card just to get free tacky t-shirts they'll never wear also complain about how much student loan debt they'll have when they graduate.
If only all of the financial problems in the U.S. were caused by student loans! Parents and students shouldn't worry as much about these loans as they do. In fact, they are some of the best deals you can find right now. This is why.
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In the last ten years, the interest rates on Stafford loans have been very low, with some years having rates as low as 3% or less. Traditionally, the Stafford loan rate changed based on the prime rate. However, the rate has been limited by law to less than 9 percent. This means that even in a bad year, the gross interest rate paid on these funds is much better than the rate on most credit cards (which average around 17 percent and can go upwards of 25 percent ).
Even though the rates are good, they only apply to the "unsubsidized" part of a student's Stafford loan debt while they are in school (defined as enrolled half-time in a degree-seeking status). Depending on how much money a family has, and the terms are also pretty good, a portion of the money that a student is eligible for may be subsidised. The government pays the interest on the loans that are subsidised while the student is in school.
The most you can borrow depends on your school year (Fr., So., Jr., Sr., and Graduate) and whether or not your parents are financially responsible for you. For a quick example, let's say you're a graduate student who borrows the maximum annual amount of $18,500 and is eligible for the maximum subsidised amount of $8,500. Your interest rate is 8.5 percent, but while you're in school, you only pay that rate on the $10,000 in unsubsidized loans.
So, the effective interest rate on the whole $18,500 loan is only about 4.6% while the student is in school.
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Stafford loans are relatively inexpensive compared to other ways to borrow money, and they also have very good terms. While the borrower is in school, they don't have to make any payments at all, but they can pay the unsubsidized part of their interest to lower their payments later. When he or she finishes school and has to start paying back the loan, he or she has a few options. One is a graduated pay scale, which assumes a low starting income that grows over time. Another is an extended term, which gives up to 30 years to pay off the loan.
What happens if the borrower wants to go back to school? The loan can be put off again if the student is still in school. Try telling the mortgage company that you won't be living in the house for a few months and would like to put off paying the mortgage.
Consolidation
Right now, consolidating student loans is still a very good option for people who need to borrow money. When loans are rolled into one, the interest rate changes from a variable rate to a fixed rate that is based on a weighted average of the variable rates. The average is based on the rates of each loan that was consolidated. Someone who consolidated once could borrow more money and then consolidate again. (If the borrower goes back to school, consolidation loans can also be put on hold.)
When interest rates reached their lowest point at the beginning of the decade, students who consolidated their loans were able to lock in a fixed rate of 3% or less for the life of the consolidated loan. Since interest rates are going up right now, the locked-in rate would probably be between 5% and 6%.
Advantages from a tax point of view
The tax treatment of student loans is the last of the four main benefits of student loans. Up to a certain limit, interest paid on student loans is tax-deductible. It phases out based on household income, but the levels are pretty high, so most recent graduates probably won't be affected (especially married couples).
How about grants?
Americans are eager to avoid loans, so they talk a lot about grant programmes, especially the Pell programme. Grants are basically free money. The money is given out based on certain criteria, but it is usually not expected to be paid back. Don't get me wrong, though: if someone offers you a grant, take it.
Having said that, going to school is an investment in your own future. Sure, it's in the country's best interest to have educated people, but that only happens if the people who live there do well in school and learn something.
Grants are fine as a part of the mix, but anyone who wants to go to college or university should be sure that they will make enough money after they graduate to be able to pay back the money they borrowed to pay for school. I know there are exceptions—some arts, for example, never pay well—and that grants make sense in these cases (though even here, I favour merit-based scholarships).
Too often, people go to college without knowing why they are there, and they don't learn anything at all. If they do that with money they borrowed, that's fine. If they do that with grants paid for with tax money, that might not be so fine. In either case, grant money rarely pays for all of the costs of school. So, we're back to Stafford loans again.
Changes are on the way, but it's still a good deal.
One part of the recently passed Deficit Reduction Act that doesn't get much attention is a part that changes Stafford loans from having variable rates to having fixed rates of just under 7%. This change is good for the government because it makes loan interest more clear. As interest rates go up over time, it will be good for students in the long run.
But in the short term, this change is bad news for people who have been borrowing money because rates have been so low. What should borrowers do? Consolidate now to lock in a fixed rate that is still a bit lower than the new rate. Once the changes go into effect in July 2006, consolidation will only create one account number and have no effect on interest rates.
Even though these changes have been made, the Stafford loan programme is still a great deal for Americans. Sure, you could make the case that debt is never a good thing, but in the U.S., we accept debt too easily. And as far as debts go, Stafford loans are among the best: the rates are low, the interest is tax-deductible, and the terms are good. If you have to choose between a Stafford loan and a credit card, get the loan from the government.
The Stafford lives!
