Q: Would it be more beneficial to take out a Home Equity Loan versus a Parent PLUS to pay for a child’s college education?
—Lou M., Brooklyn
A: PLUS loans should be your last resort.
Sure, these federal loans allow parents to borrow up to the total cost of their child’s college education, minus any other aid the student may be receiving. But that’s where the good news ends: PLUS loans currently carry a 6.41% rate, and without Congressional intervention, that rate will jump to 7.21% come July 1. Plus, these loans also come with an “origination” fee of about 4.3% of the principal amount you borrow.
Additionally, the credit standards required for PLUS loans have gotten tighter in recent years, notes Fred Amrein, a financial planner who specializes in college funding, financial aid and student loan repayment. (Though there is one upside to this: If you’re denied a PLUS loan, your child can receive additional student loan money above the standard limit.)
Rather than you taking on a PLUS loan, Amrein advises pushing your child to take out the full amount they can in federal student loans—$5,500 to $7,500 annually for dependent students whose families weren’t turned down for a parent PLUS loan.
The interest rates for student loans are significantly less: After July 1, they will be 4.66% for subsidized and unsubsidized federal direct undergraduate loans and 6.21% for direct unsubsidized graduate loans. These loans have lower fees, too—about 1.1%. Students also aren’t subject to a credit check as parents are.
Students also have more flexibility with their repayment plans if they can’t keep up with payments than parents have with PLUS loans, says Amrein. And student loans can be forgiven or reduced through the teacher or public service loan forgiveness programs. Parents who take out PLUS loans can only have their loans discharged if the child dies, or if the borrower dies or becomes totally and permanently disabled.
Don’t want your child to be burdened with debt? You can treat the student loan in the same way as the PLUS—and you simply pay the bills for your kid.
If you need additional funds above the student loan limit, home equity financing is probably your next best move. Via a home equity loan or line of credit, you can borrow up to 85% of the equity in your home, with fees similar to those you paid when you financed your original mortgage. And in either case, up to $100,000 of interest you pay on home-equity debt is tax-deductible.
A home equity line of credit will have a lower initial cost of money than a home equity loan, but both have some drawbacks.
With a loan you are borrowing a single lump sum, usually at a fixed interest rate—currently averaging 6.22%, according to Bankrate. You’ll have to know upfront how much you’ll likely need to fund your child’s entire college education, since you probably won’t be able to take out a new home equity loan each year they’re a student. Also, once you have the loan, that amount becomes an asset and can reduce the amount of financial aid your child qualifies for by thousands of dollars, says Amrein.
A line of credit is similar to a credit card, allowing you to draw from a line in smaller sums as needed, up to a certain fixed amount. HELOCs typically only require you to pay interest for the first several years and have an average interest rate of 4.9%. But that rate is variable, meaning your monthly payments can change during the course of your repayment period. Borrowers should be prepared for their rates to rise since interest rates currently remain near historic lows.
Because you are borrowing smaller sums over time and using those to immediately pay bills with a HELOC, the money is not viewed as an asset and won’t affect financial aid awards. But because these loans are variable, they’re considered a little riskier since your interest rates could rise over time, though they do have set lifetime caps of—gulp!—18% in most states.
But analysts warn that China's growing appetite for debt coincides with a growing appetite for risk
China’s corporate debt raced ahead of the US by more than $1 trillion in 2013, to $14.2 trillion, beating analysts’ forecasts by one year, according to a report released Monday by Standard & Poor’s. The new report highlighted not only the growing clout of China’s financial sector, but also its growing appetite for risk.
S&P estimates that one-quarter to one-third of the debt originated from China’s shadow banking sector, a system of informal lending that operates outside of government oversight. A series of defaults in that sector alone could expose one-tenth of the world’s corporate debt to a sudden contraction, the report warns. “Given the substantial share that shadow banking contributes in financing not just China’s corporate borrowers but also local and regional government financing vehicles, a sharp contraction would be detrimental for business generally,” the analysts wrote.
One graph in particular showed that the risks might be thriving in the shadows. S&P compared cash flows and indebtedness among China’s corporations to 8,500 of their global peers. These measures together offer a rough gauge of their ability to repay loans, and unfortunately here too, China surpasses the rest of the world.
We're extending the terms of our car loans, and it's costing us thousands.
The average length of new auto loans reached a record-high of 66 months, or 5.5 years, credit bureau Experian found in a report released this week.
More than 40% of all new loans signed for the first part of this year lasted 61 to 72 months, while loans extending out 73 to 84 months made up 25% of all new leases signed. Meaning less than 35% of us take out financing for five years or less.
And that’s costing us, big time.
“Beyond lower monthly payments there are no pros to this,” says Ron Montoya, consumer advice editor for Edmunds.com. “In fact there are a ton of reasons why you shouldn’t go past a five-year loan.”
Among the reasons for limiting loans to no more than five years:
Higher Interest Rates: The longer you finance a car, the more interest you’ll pay on it. Not just because you’ll be accruing interest and paying it off over a longer period, but because you’ll also be charged a higher interest rate for the loan.
“The best rates are offered between 36 to 60 months,” says Kelley Blue Book’s Alec Gutierrez. “Five years is really the breaking point; after that, rates jump up.”
Last year, the average interest rate for a new auto loan with a term between 55 to 60 months was 2.4%. That rate jumped to 4.8% when the term was between 73 to 84 months.
That means if you were to finance a car for the current average amount, $27,612, for 55 months at 2.4%, you’d pay $1,574.30 in finance charges. But if you were to finance that same car for 84 months at 4.8%, you’d pay $4,953.12 in charges.
The 84-month loan would “save” you $142.98 per month in payments, but cost $3,378.82 more in interest and give you about two-and-a-half years more of car payments.
Negative Equity: Whenever you first purchase a car, you’re considered underwater on it, meaning you owe more than the car is worth. The longer your car loan, the longer it will take you to build equity in your car and get “above water.”
If you have little or no equity in your car, you can’t sell it at a profit. A buyer will only pay what a car is worth, not what you owe on it. You’ll still have to cover the remaining balance. It works the same way with insurance companies if you get in an accident and your car is totaled.
Lower Resale Value: The longer you own a car, the less it’s worth and the less desirable it becomes.
Edmunds found that at five years, a car has lost 55% of its value, on average; at seven years, it’s down 68%. Dealerships and private buyers will pay less for your car, and that could hurt you if you were planning on using that money as a big source of your down payment for another car.
What to do before signing your next auto loan
Make a large down payment. Montoya recommends putting down 20% of the total car price, or as much as you can. This will bring the total amount you need to finance down.
Get preapproved financing. Before going into a dealership, apply for a loan with two or three financial intuitions you do business with, advises Gutierrez. This way, you know if you’re getting a fair offer from the dealership, and can ask the dealership to beat the bank’s offer.
Negotiate financing on total car price, not just on monthly payment. Use the total car price to run different monthly payment and interest scenarios to see if you’re being upsold or pushed into a longer loan with an online calculator like this one from Bankrate.
Consider cheaper options. If the car you’re looking at only fits into your budget with monthly payments stretched out over six or seven years, you may be shopping outside your actual price range. “Reassess your priorities and decide if you absolutely need that trim level, or even that model,” says Gutierrez, “because if you can squeeze into a five-year loan, it’s just smarter.”
The commerce startup aims to simplify a business with a not-so-great image
Among the various ways that a small business can get access to funds, the cash advance—borrowing against money which a company hasn’t yet made, then paying it back as a percentage of future sales—doesn’t have the best of reputations. Typically, it’s a last-ditch measure taken by a company which can’t convince a bank that it’s a good prospect for a loan, and the fees involved can be steep and complicated.
Depending on how you look at it, that makes it an odd business for Square to enter—as it’s doing with a new service called Square Capital—or a logical one. Twitter co-founder Jack Dorsey’s startup, after all, sees its purpose in life as bringing elegant simplicity to transactions which are usually neither simple nor elegant, as it did with its tiny credit-card swiper. And the whole idea of Square Capital is to make cash advances a more straightforward, respectable funding option.
Among the unusual things about Square Capital is the application process—or lack thereof. A company can’t seek an advance. Instead, Square reaches out to prospective businesses which it’s picked as good candidates based on the their statistics as revealed through the sales they’ve processed using Square.
“We send an offer to the seller based on our holistic understanding of their business,” says Gokul Rajaram, Square’s head of product.
Square is also aiming to make the math involved in an advance transparent. As an example, Rajaram says that Square might offer a small business a $10,000 advance. The total payback might be $11,000–making the cost of the advance $1,000–and Square might hold back 5 percent of the business’s sales through Square until it’s recouped the $11,000. A merchant who accepted this deal would receive the money as soon as the next day, and then would monitor it through the same dashboard used for other Square tasks.
All of those figures are hypothetical: Square says that the advances, fees and payback percentages will all vary from offer to offer. That makes it tough to make any sweeping generalizations about how costly an option Square Capital is compared to other sources of small-business funding, from banks to startups such as Dealstruck, Kabbage and OnDeck.
Unlike a loan with an interest rate and fixed payments, one of the advantages of a cash advance is that the pace of the repayment auto-adjusts itself to reflect cashflow, since it’s based on a percentage of sales. If a business boomed after receiving the advance, it might end up paying back the advance more quickly than it expected; if it went through a seasonal lull, or sales turned just plain lousy, the payments would be smaller and the process would take longer. Rajaram says that the goal is to offer amounts which typically will take around ten months to repay.
Square says that it’s already advanced tens of millions to small companies in Square Capital’s pilot phase, such as New York-based coffee chain Cafe Grumpy; San Francisco comic-book collectible shop ZeroFriends; and Follicle Hair Salon, another San Francisco business which used two advances to buy twelve new chairs, each of which can bring in an additional $5,000-$8,000 in sales per month. “It’s part of our broader mission of helping sellers grow,” Rajaram told me.
Among the growing companies which Square Capital might help is Square itself, which has lately been looking to sources of revenue beyond the 2.75 percent processing fee it collects on transactions handled with its card reader. Earlier this month, for instance, it announced Square Feedback, a service for collecting and addressing comments from customers.
The company acknowledges that it’s currently losing money–it’s still in a mode of investment and expansion rather than focusing on turning an immediate profit–and its own financial future is the subject of constant speculation, including rumors of everything from it getting ready to go public to shopping itself to potential acquirers. The more well-rounded its offerings, the brighter its future could end up being.