Everything to Know About College Financial Aid and Student Loans
There is a lot to absorb about college financial aid and student loans but it is better to understand this before you make potentially lifelong commitments to burdensome debt repayments.
We’ll cover this in three parts:
- The college financial process
- Borrowing student loans
- Repaying student loans
The College Financial Aid Process
If you’re navigating the complex and maddening college financial aid journey, here are my tips to remain financially solvent and reasonably sane through the process.
1. It’s a one-way mirror.
The financial aid system is designed for the colleges to know everything about your finances while disclosing nothing about their process to award financial aid. Because the FAFSA requires you to disclose assets as well as income, they know more about you than the IRS. If you want financial aid, you follow their rules.
2. Don’t over-borrow as you will be on the hook for these loans.
Student loans are almost never discharged in a bankruptcy so make sure you can repay all the debt you incur. If not, a default will follow you through your lifetime as fees, penalties, and interest will accumulate and your future wages, tax refunds, and Social Security benefits could be garnished.
3. Submit the FAFSA early.
Financial aid budgets are finite and you don’t want to be last in line. The best way to avoid this is to submit your application and FAFSA as early as you can.
4. Need-based and merit financial aid policies vary widely.
Financial aid comes in two flavors — need-based and merit. Need-based aid is determined by your expected family contribution, derived from your FAFSA submission. Merit aid is for any reason the college chooses to encourage your enrollment. Some colleges offer no merit aid at all, while others lean heavily on it.
5. Colleges are under no obligation to meet your full financial need, and few of them have the financial resources to do so.
Don’t assume that because they have accepted you, they will make it affordable. It’s more likely they won’t.
6. The college financial aid office is not your guardian angel.
The mission of college financial aid advisors is to get you to attend their college, not to protect your financial interests. Be wary when working with them — they want to enroll you and to do so, they may offer you loans you may not be able to repay.
7. Your financial aid award may not be guaranteed for all four years.
Read your financial aid award letter carefully and be sure that the grants will continue for all four years of college. If you’re not clear, reach out to the college for written clarification before you make a commitment. If not, you may find your grants reduced after the first year.
8. Focus on the net price and not the list price.
In college-speak, the list price is known as the “cost of attendance” (COA). You only care about the net price, which is the COA less any grants you receive. (Do not deduct loans to determine your net price as you will be paying those back.) This net price is the best number to use when comparing the financial aid offers of different colleges.
9. Less selective colleges may be more generous with financial aid.
Colleges compete for students and for all but the most selective colleges, discounting is routine. For any particular student, a “safety” school may have a lower net price than a “reach” one. Colleges run a business with the goal of maximizing revenue by enrolling a full class of students at the highest net price they can achieve.
10. Many private colleges are on shaky financial footing.
Before you enroll at a private college, be sure it is financially sound. That’s not easy to determine but two measures to assess are the size of its endowment and its student enrollment trends. If the endowment is small or enrollment is declining, proceed carefully as the college may not survive long into the future.
11. Private colleges may be less costly than public ones.
While private colleges almost always have a higher COA than public ones, their net price may be lower. Grants from private colleges are often larger so their net price remains competitive with state colleges.
12. Out-of-state state universities are often the most expensive.
State universities have a higher COA and less generous financial aid for out-of-state students. If you’re from NJ but your heart is set on UCLA, be prepared to pay up.
13. Independent scholarships may not help.
Colleges vary in how they factor independent scholarships into their financial aid awards. Some reduce the grants that the student would otherwise receive, but others don’t. You would have wasted your time if your college simply reduced your grant aid by an amount equal to the outside scholarships you earned, rather than allowing you to borrow less.
14. Federal student loans are usually the best borrowing option.
In most cases, maximize your federal student loan borrowing before taking out any other loans. Why?
- They are eligible for income-driven repayment plans.
- They are not a legal responsibility of the parents.
- Their rates and fees are competitive.
However, for undergraduates, the maximum borrowing limit is relatively low, so it may not be enough. Keep in mind that federal student loans are better than federal PLUS loans (parent loans to undergraduate students). PLUS loans have higher rates and are not eligible for income-driven repayment plans.
15. College is not for everyone.
Don’t fall for the trap that everyone must go to college. You can lead a fulfilling and productive life without a college education and its associated debt. The worst outcome is to attend college for some number of years, conclude it is not for you, and then drop out, after having incurred much debt. If you’re not sure, start with a low-cost community college class or a free online class. Go to college when you’re ready.
Student Loan Borrowing
Borrowing too much money to pay for college can get you into lifelong financial trouble. Remember that bankruptcy laws make it nearly impossible to discharge any student loan debt.
Parents, keep these points in mind:
1. Don’t borrow more than you can comfortably repay within the framework of your current income and living expenses.
If you are not certain you can afford to pay off these loans over a 10-year term, don’t borrow the money. Be realistic about what you can afford to repay and don’t risk your retirement or your home. Don’t borrow the money if your plan is to figure it out later.
Separate the question of how you should finance this expense from the question of how much you should borrow, if anything. Just because you can take out a home equity, PLUS, or 401K loan, doesn’t mean you should.
2. Don’t co-sign loans for your children.
That’s a clear signal that you’re both over-borrowing. It not only risks the financial security of both of you, but it also could create future family conflict around these outstanding debts.
3. Your teenage children will not understand the future obligations to which they commit when taking out student loans.
Taking on future debts is too abstract and unfamiliar for teenagers to fully grasp, and they will make poor financial decisions if on their own. Yes, teenagers have minds of their own and may not respond well to parental guidance, but we need to protect them from making poor judgments with lifelong consequences. Be the guardrails they need when making these decisions.
Students, keep these points in mind:
1. You won’t fully grasp the loan commitments you’re making so be extra careful with how you proceed.
Convert the loan amount into what the future monthly loan payment (assuming a 10-year term) is going to be. This is how most people buy homes and cars — they focus on the monthly loan payment as much as the total price.
2. You will owe more than you borrowed.
Your loans will be accruing interest while you are in school and when you begin repayment that unpaid interest is added on to the loan balance. Factor this into your calculations. (So-called “subsidized” Stafford loans are the exception to this.)
3. Don’t borrow more than the Federal student loan (i.e., “Stafford”) maximum amounts.
For most students, this will result in ~$30,000 of debt at graduation. This should be affordable to repay in most circumstances and if not, you will be eligible for an income-dependent repayment plan which will serve as a safety valve for all of this debt. Any more debt than this is risky, unwise, and a signal that you’re getting in too deep.
4. Don’t co-sign loans with your parents (or anyone else).
That’s a trap for both of you and another signal that you’re borrowing too much.
5. Don’t assume you’ll graduate in four years.
There is a good chance it will take closer to six years to complete your degree, particularly if you’re working (see my next point). Factor this into your calculations.
6. Work during your college years.
Get a part-time job. Not only do you need the money, but it will:
- leave you with less idle time to spend money you don’t have
- motivate you to graduate as quickly as you can
- prepare you for your post-college working life.
What if you cannot afford the college you had in mind?
Don’t hope that things will work out. That strategy will likely leave you with a lifetime of regret.
Consider these options:
- Attend your state university, instead of a private college.
- Attend a state college, instead of your flagship state university.
- Begin at a community college and take courses whose credits can transfer to a four-year college.
- Live at home instead of in a dorm.
- Study part-time and work full-time.
- Study full-time and work part-time.
- Take a gap year and work to save as much money as you can.
Any of these choices will put you in the mainstream of most American students and families.
The worst outcome is to over-borrow and exit college with an unpayable debt that will remain a ball and chain secured to your ankle. Don’t do it.
Student Loan Repayment
You’ve finished college — congratulations — and now it is time to repay your student loans. Here are ten tips to help you navigate the repayment process.
1. You owe more than you borrowed.
Your student loans started accruing interest (unless they were subsidized federal loans) while you were in college and the loans were not being repaid. When it comes time to begin repayment, this accrued interest is “capitalized” (i.e., added onto your principal) and you’ll find your loan balance is greater than the total amount you borrowed.
2. Filing for bankruptcy won’t save you.
Congress, exercising its infinite wisdom, changed the bankruptcy laws to make it nearly impossible to discharge student loan debts in bankruptcy. You would need to pass the “undue hardship test” which is unlikely for almost everyone. Declaring bankruptcy is not a safety valve if you get into financial trouble.
3. Don’t default on these loans.
Because bankruptcy is not an option, if you fall behind on your payments, loan collectors will chase you incessantly and fees and penalties will be added to your loan balance. In addition, wages, tax refunds, and even Social Security payments may be garnished. A default would be very costly.
4. Deferment and/or forbearance won’t help over the long term.
These are approvals to temporarily suspend your payments. However, they are only available for federal loans and not for private ones. In most cases (except for subsidized loans), your interest continues to accrue and your loan balance grows every month. Only take this option if you have no other choice.
5. Consolidation of your loans is usually sensible.
By consolidating your loans, you minimize the number of payments each month and the number of loan servicers with whom you interact. However, it will not save you money as the interest rate on your consolidated loan will be the weighted average of the underlying loans.
If you have extra funds to contribute to your loan payoffs, then I would notconsolidate your loans. Instead, devote all the extra payments to your highest interest rate loan and then work your way down as you pay them off sequentially.
If you consolidate, do not mix federal loans with private. Keep your federal loans separate in case you opt for an income-driven repayment plan.
6. Understand and evaluate income-driven repayment.
Income-driven repayment refers to a set of repayment options for federal student loans where your monthly payment is tied to your income, rather than your loan balance and interest rate. Note that private loans and federal PLUS loans (Parent Loans to Undergraduate Students) are not eligible for these repayment plans.
The different choices are complex in their implementations and nuances but generally, your monthly payment is anchored to ~10% of your adjusted gross income and any remaining loan balance is forgiven after 20 years of payments. You can see the differences and details of the three main plans — REPAYE, PAYE, and IBR — here.
There is one major drawback to all of these plans. After you complete the required payments, your remaining loan balance is cancelled. That’s the good news. The bad news is that this loan write-off will be treated as taxable income in that year and you will owe income tax on the amount of the write-off.
Note that as part of the COVID relief legislation, Congress changed the law to allow these loan write-offs to be tax-free but the change is not permanent. Proceed carefully and see my next point.
7. Understand the Public Service Loan Forgiveness option.
PSLF is a subset of these income-driven repayment plans. With PSLF, if you work for a qualifying employer — essentially any government agency or a 501(c)(3) non-profit — and make 10 years of payments, your loan is written off.
More importantly, the remaining loan balance that is written off is not taxable. As I described in the prior point, this can make a big difference.
Especially if you attend graduate school and have amassed a large amount of qualifying debt, you should carefully weigh PSLF as you consider your career plans. It is much better than standard income-driven repayment and can significantly improve your lifetime financial health.
Congress is considering limitations to PSLF so be sure to monitor any changes that are coming if you are counting on this to finance your education.
8. Be organized and methodical.
Ensure your payments are on time and in full every month. Automate electronic payments directly from your bank. Create a simple spreadsheet that lists each loan, the servicer and the online access credentials, the interest rate, the monthly payment, the approximate loan balance, etc. When you move, be sure to communicate with your servicer so they know your new address.
9. Choose the repayment plan that is best for you.
The default repayment plan is a 10-year level payment for most loans. That may make the most sense, but not always. Be proactive about selecting the best repayment plan for your situation, including explicitly deciding if you’re going to enter into an income-driven payment plan.
10. Financing graduate school has different considerations.
As you’re working through your repayment options, factor in whether you will attend graduate school in the future. The financing options for graduate school are different; in particular, an income-driven repayment plan may make more sense when combining undergraduate and graduate school debt.
Navigating college financial aid and borrowing money can be a complex and easily misunderstood process. No one is looking out for your interests and it is a lot of pressure to impose on a teenager. However, the better informed you are when you begin the process, the better your chances to remain sane and solvent at the end of it.
Update: The NY Times reports about colleges changing their pricing policies. Essentially, some are cutting their published (i.e., “list price”) tuition prices to more closely reflect reality, but they are also reducing the financial aid