Marc Ruiz of Oak Partners, Mind on Money: College Loan Process Must Be Managed Closely

Marc-Ruiz As we talked about last week, my family is in college shopping mode. We’ve got our list narrowed down to a few different schools. A few are smaller private Catholic universities and, of course, Purdue. The “sticker price” of the private schools have me concerned about cost, and in order to get even merit-based (grades and scores) student aid, the family must fill out the Free Application for Federal Student Aid, known as the FAFSA, which I did last week.

The point of the FAFSA process is to determine each family's Expected Family Contribution or EFC. This number, expressed as a non-intuitive code, determines the needs-based (income and asset) student aid programs the student may be eligible for. This week we will go over some of these programs.

The main terms in this conversation are subsidized, unsubsidized and grant.

A subsidized loan is a government loan product that involves attractive terms. Interest on a subsidized loan is actually paid by the government while the student is in school and for six months after school. Subsidized loans are the best type of student loan; I might even go so far to say they are the only “good” type of student loan. Subsidized loans are awarded based only as determined by family financial need (EFC). Government names for subsidized loans are Perkins loans and Stafford Loans.

A cirect unsubsidized loan is like a typical non-student loan in that interest is paid by the student or family immediately. While payments may not be due on an unsubsidized loan while the student is in school, interest begins accruing immediately and causes the loan’s balance to grow if no payments are being made. The amount of direct unsubsidized loans is awarded by the school being attended, based on costs, and are not based on financial need.

In order to be as confusing as possible, the government calls direct unsubsidized loans Stafford loans as well. It is important to note that some Stafford loan awards involve both types of loans, so it's important to know which type has been awarded.

Another type of government unsubsidized loan awarded directly to parents is the Federal PLUS loan. PLUS loans involve credit underwriting to determine terms, and are in my opinion not very attractive, involving both higher interest rates and higher origination fees. Interest is never deferred on a PLUS loan. If parents aren’t making loan payments while their student is enrolled, then the accruing interest is causing the loan balance to grow.

The most attractive government student aid benefit is of course a grant, which, simply described, is free money from the government that does not have to be paid back if the student stays enrolled and finishes his or her program. It is extremely important to note, however, that a grant can become repayable if the student does not stay enrolled and complete the academic program. Government grants are awarded based on need, but also service for teachers or soldiers serving in conflict zones. The most commonly awarded need-based grant is called a Pell grant.

Now for the soapbox. In my experience, student loans are perhaps the most mismanaged and abused financial product available today. They are, of course, at times a necessary evil, but these products can quite frankly ruin the financial life of a young person if the loans are not understood and managed closely.

These loans should never be used for lifestyle expenses (cars, food, parties, trips). The payment deferral period while the student is enrolled can cause the loan balance to snowball into becoming unmanageable. If you don’t understand these programs and how they work, please get advice. Financing an education must be approached with the diligence afforded to any other large purchase, as outside of a home it is likely to be the most expensive process a family ever has to navigate.