RESOURCES TO PAY FOR COLLEGE

In the last blog post, The Current Reality of Paying for College, we discussed the nature of college funding, the misalignment between the financial services industry and parents, and how we parent. Specifically, we examined the details behind the Student Loan Bubble and compared default rates to the mortgage delinquencies of 2008. The numbers show that the student loan bubble is already here. For those with current student loans, a new mindset must lead the way in creating innovations that minimize interest paid over the loan’s lifetime. Families with college-bound students must focus on how they save for, shop for, and save on the cost of college. This blog post reviews the first of three steps in saving and shopping for college, as well as the cost involved.

Before we dive into the specifics, we must ask a question.

How do families currently approach college funding?

A new trend worth noting shows that an all-time-high number of parents are saving for college: 72 percent according to a recent Fidelity survey (1.) Seventy-six percent of the respondents are very or somewhat familiar with the popular 529 account. The survey discusses three knowledge gaps: 1) how much a family should be saving and the future cost of college; 2) understanding the fundamentals of 529 accounts; and 3) how saving for college affects financial aid eligibility (1.)

The last point of the study deserves clarification. The study mentions having grandparents help save for college but doesn’t describe how to do this. If money is gifted to parents who then put the funds into a 529, then yes, there is minimal impact on the FAFSA funding formula. However, if grandparents put the funds directly into the 529, then pay the school from the account, major implications may affect financial aid during the student’s following school year. Up to 50 percent of the money distributed from the grandparents’ 529s may be taken away in need-based aid. This is where working with a fee-only financial planner may help.

Increased savings will benefit college-bound students. However, as noted in the three gaps from the Fidelity survey, understanding the cost of college is important. Financial aid trends in grants, loans, and tax credits play another important role in financing higher education.

College Funding Sources: Loans

The following bar chart highlights the difference in federally subsidized loans on the funding percent from the 96-97 school year to the 16-17 school year (2.). This funding source was cut by more than 50 percent. By comparison, notice the large increases in federal unsubsidized, Parent PLUS, Grad PLUS, and nonfederal loans.

The increases are worth noting because of the large financial strain they put on students and parents. In my other blog post, you can see the result of this strain. As further proof of the difficulty in servicing these large increases in student loan debt, take a look at the following chart (2) showing deferment, forbearance, and default. Keep in mind that filing bankruptcy on student loans is difficult.

https://trends.collegeboard.org/student-aid/figures-tables/repayment-status-federal-education-loan-portfolio

 

Is easy access to money partially to blame for this increase in student loan debt? It seems that little regard is given to students’ ability to service the debt beyond graduation. This comment does not dismiss consumer responsibility but rather acknowledges the behavioral aspect of shopping for college from a consumer point of view.

How we shop matters.

How we shop matters to the point that financial institutions limit how much we can borrow. Imagine going to the Ferrari dealership as a fresh college grad making $45,000 a year and applying for a car loan. What would a bank tell a young couple trying to buy $1,000,000 on an income of $75,000? Of course, the bank will say no. In fact, the bank will pre-approve you for an amount so you know the maximum price range in which you can shop.

Wise and informed consumers will have a much lower self-imposed limit and will shop around for the best bargain. Why do lenders limit the amount you can borrow? The lender must limit the risk associated with your total debt load, which makes credit scores, income, and assets part of a standard review before one borrows money for a major buy. These debts can typically be claimed as part of a bankruptcy.

Student loans have much lower standards for borrowing money. Over their undergrad years, all students qualify for up to $27,000 in Stafford loans with no questions asked and no credit check. Parent PLUS loans do require a credit check but there is no total limit on the loans. Private loans vary, but I meet people coming out of college with hundreds of thousands in student loan debt. Can you blame the student loan lender for these low standards? As mentioned earlier, it affects the student and, likely, the parent.

As consumers, we must treat the college shopping experience the same way a bank imposes limits on how much one can borrow for a home. Also, we do not buy the first home we see. Instead, we look for homes that meet our needs at a great price. Valuing the education from one institution may be similar to the way in which we value both market aspects and personal preference in pricing a home.

College Funding Sources

There are five broad personal funding sources: parent resources, parent loans, student resources, student loans, and other help. Scholarships and grants may pay for college, but the family does not have control over whether the money is awarded.

Parent resources include both income and assets collected for college. Here are a few examples: 529s in the parents’ name, taxable brokerage accounts, Roth IRAs in which the money was saved specifically for college, monthly cash flow (kids do not live with parents for free and may cost $250-$300/month), tax credits (for example, the Annual American Opportunity Tax Credit), 529 state tax credit, and public matching programs like Upromise or the Hancock County Promise in Indiana.

Parent loans typically include Parent PLUS and private student loans as the two most common ways for parents to borrow money to pay for college. A third possibility includes taking out a home equity loan. If you are a parent over the age of 62, a reverse mortgage may be another avenue to examine. (Please consult with your financial advisor to review how these may or may not fit your needs.)

Student resources include income and assets similarly to parents’ assets. Many of the same types of accounts apply but with a few differences. Taxable accounts are referred to as UTMA or UGMA accounts, and the parents typically decide about the funds. If monthly cash flow exists, it likely comes from a part-time job. Parents usually claim the tax credits while the child attends college (normally, the child remains a dependent for an undergrad degree). Do not forget that these assets weigh heavily in determining the expected family contribution (how much the government thinks you can pay for college).

Student loans start with Stafford loans, then move into private loans. When a student enters the private loan market, usually a co-signer must be on the loan. Make sure all parties understand the loan’s covenants. Students often get in trouble because they do not understand how the debt works after graduation or if they drop out of school.

The last category covers all other sources of funding. Grandparents gifting money to mom, dad, or grandchild and 529s saved in the grandparent’s name are the two most common funding vehicles in this category. Families must be aware of how this category may affect any financial aid the student receives.

A good college funding budget would look similar to the example below.

One final important detail must be addressed. Notice the First Year Salary and Student Loans sections. These numbers should help set the maximum student loan debt a graduate should accumulate after leaving college. For every $10,000 in student loan debt, you should expect roughly a $100 payment for 10 years. Because not all majors produce the same level of income, the student should accumulate the appropriate level of debt.

Next Steps:

  1. Gather your tax return, W2s, and asset statements.
  2. If you do it yourself, work with your student to create a college funding budget.
  3. Work with an advisor? Schedule a meeting with you, the student, and the advisor to walk through this college funding worksheet.
  4. If you need help, contact me at ncarmany@thewatermarkgrp.com or call 317-805-8040 to schedule a time for us to walk through your college funding budget.

 

Sources:

1.  https://www.fidelity.com/about-fidelity/individual-investing/families-underestimating-future-college-costs   
2. https://www.fidelity.com/about-fidelity/individual-investing/families-underestimating-future-college-costs

3.https://trends.collegeboard.org/student-aid/figures-tables/repayment-status-federal-education-loan-portfolio

 

DIFFERENT TYPES OF STUDENT LOANS

A great college funding plan considers the different types of student loans and has three steps. The first step sets up your resources and budget. The last blog post focused on this topic. We reviewed how to create a college funding budget and compared it to the pre-approval process of buying a home. Also, the post explored the different funding categories. Loans made up two of those categories – one for parents and one for students. The second step in your college funding plan creates a smart lending strategy so the student or parent does not create a future financial burden. The last step is to shop for college. We will study this topic in later posts.

Today, we focus on the second step by examining the different types of student loans. As mentioned in other works, there are two major categories of student loans: federal loans and private loans. Each category may break down further into student or parent loans. Student loans refer to debt that is in only the student’s name. Parent loans may be in the student’s name but the parent acts as a co-signer, or the loan may be in only the parent’s name.

FEDERAL LOANS

Stafford loans are the most common type of federal student loan. These loans will be either subsidized or unsubsidized. Among the loans, three differences exist: 1. The government pays the interest on subsidized loans while the student attends college. 2. The eligible amounts for subsidized loans are lower than those for unsubsidized. 3. A student must qualify for the subsidized loan, while every undergrad student is eligible for the unsubsidized loan. The student qualifies for subsidized loans by demonstrating financial need. To put it in a simple math formula (1.):

Cost of Attendance – Expected Family Contribution = Demonstrated Need

As you saw in my other post about expected family contribution, calculating this number is anything but easy. However, from the formula above, you get the basic of idea of how to qualify for subsidized Stafford loans. The government manages the amount it will cover in loan interest by limiting the amount of the subsidized loan. Depending on the amounts, a student may borrow the following under a subsidized loan: $3,500 for freshmen, $4,500 for sophomores, and $5,500 for juniors and seniors.

As mentioned earlier, every student qualifies for unsubsidized loans. The dollar amount a student may borrow depends on the grade level: $5,500 for freshmen, $6,500 for sophomores, and $7,500 for juniors and seniors. With this type of loan, the interest starts accumulating at the loan’s origination.

The two types of loans may be used together but the amount borrowed in any one year should not exceed the higher limit of the unsubsidized loan. If a student qualifies for subsidized loans, this will be used to the maximum first; then an unsubsidized loan will be added to the amount and not exceed the limit. Interest rates are fixed for the life of the loan and reset for new loans every year.

Perkins loans are another type of student loan that may be used. They are low-interest loans for grad and undergrad students who demonstrate exceptional financial need. The school is the lender and payments are made to the school or its service provider. Not all schools participate in the Perkins loan program, and funds may be limited (2.) Students with a high need should check with the school’s financial aid department for participation details. This loan program is not as popular as Stafford loans.

Parent PLUS

Parents may help students pay for college using a Parent PLUS loan. Parents of PLUS loans may acquire loans for dependent undergraduate loans (3.) These loans are not accessible to other students, namely graduate and independent students. Divorced parents may both acquire loans, but the total between them cannot exceed the loan limits (3.)

The total amount that parents may borrow for any one year follows the formula below:

Full annual cost of attendance – other financial aid the student received = Potential PLUS loan

Parent PLUS loans require no debt-to-income ratios and are not dependent on the borrower’s credit score (3.) As a result, the interest rates on these loans are rather steep. The current interest rate for the 2017-2018 academic year is seven percent with a 4.264% origination fee, making the real first-year rate for the loan 11.264%. As you can see, this high rate can quickly put families in trouble. Now just imagine the problems faced by families that take out these loans year after year.

Repayment of the loans typically starts 60 days after the loans are fully dispersed (3.) However, loans after July 1, 2008, can be deferred while the student attends school at least half-time (3.) The standard repayment applies to a 10-year repayment schedule. Income-based repayment schedules typically cannot be used with Parent PLUS loans, but they are eligible for student loan forgiveness (3.) PLUS loan consolidation cannot be done with other federal loans in the student’s name.

To apply for PLUS loans, parents fill out the FAFSA, then request the loan through StudentLoans.gov. You can also contact the financial aid department of the student’s college or university.

Private Loans

Private student loans vary greatly in terms, payment provisions, and features. For the most part, private loans lack many of the common features of federal loans, like fixed interest rates and income-based repayment plans, and are not subsidized (if you qualify). Most private student loans are issued by banks, credit unions, state agencies, or even the schools themselves.

Many private loans require repayment while the student attends college. Some of these loans require an established credit history or a co-signer (often the parent). Student loans commonly use variable rates. If interest rates rise, the loans become more expensive. Additionally, the loan may not be consolidated into a Direct Consolidation Loan and it may not have forbearance or deferment options.

In general, private loans do not compete with the flexibility or features of most federal loans. However, private loans constitute one of the fastest growing types of loans. See the graph below.

 

As noted above, the federal government limits the amount a student may borrow in Stafford loans. The price of tuition continues to rise year after year. As a result, programs like Parent PLUS and private student loans experience large growth.

Summary

Many graduates to wonder how they will pay back their complicate and confusing student loans. As we saw, student loans divided into federal and private loans and further split into parent and student-only loans. Federal loans give the borrower attractive terms as compared to private loans in general.

Student loans are the focus of the second step in creating a smart college funding plan. The student and family should know how much they can afford if the college budget is established up front, thus reducing the number of surprises upon graduation.

Coming Up

The next post discusses paying back student loans. It starts with a smart lending strategy.

 

Sources:

  1. https://www.edvisors.com/fafsa/estimate-aid/financial-need/
  2. https://studentaid.ed.gov/sa/types/loans/perkins
  3. https://www.edvisors.com/college-loans/federal/parent-plus/introduction-to-federal-parent-plus-loans/

Navigate The Stock Market Volatility

 

Stock Market Volatility

1. with the recent price swings you be getting a little scared of the markets and wonder if another 2008 is upon us.
2. we do not know for sure but let’s review a few a things.
– The large point drop in the DOW of nearly 1600 points was large at 6.26% but not the largest in percentage terms
on 8/24/15 the dow saw a 1089 point drop or 6.6%
– 5/6/2010 saw the flash crash with the DOW Dropping over 9%.
POINT: it is not the down days that define the success of an investor. It is staying in for the good days. I.e. remove the top 10-20 days and things really do start looking bad, but you need to stay invested.
– On average we see in an intra-year drop from peak to trough of 13.8%.

2. It is your stock/Bond/Cash ratio that best explains your return and volatility over time at over 90%.
– If you were extremely nervous perhaps we need to have a conversation about your capacity for risk and risk perception.
– It may be time to change your longer-term allocation.

3. We use a disciplined approach to match your portfolio to your goals. Accomplishing your goals is really what this is all about any.
– Matching your investment portfolio to your goals.
– How to use a bucketing methodology.

We use an academic approach to factor-based investing
The premiums:
1. Stocks outperform bonds over time.
2. Small-cap stocks outperform large-cap stocks over time.
3. Value stocks outperform growth stocks over time.
4. Profitable stocks outperform stocks with low profits over time.