Q: “My daughter will be starting college this fall. I’m estimating the tuition will be about $25,000 each year. I’ve got about $45,000 put aside in a 529 for her. When should I tap that money?” —Henry Winkler, Colorado
A: The first thing you and your daughter should do is fill out a FAFSA, the federal financial aid application. Even if you think your household income will be too great to qualify for aid, it’s worth applying just to be certain, says Mark Kantrowitz, publisher of Edvisors.com, a website that helps people plan and pay for college. “I have seen many cases where families assume they won’t receive any aid, but actually do qualify based on the number of children they have currently attending college or because the high costs of the tuition resulted in a lower than expected family contribution amount.”
Don’t worry that the savings you currently have in your 529 will hurt her chances for aid either. Federal aid will be reduced by no more than 5.64% of the value of the account and account distributions are not considered income, Kantrowitz says.
Next, she should apply for the most available in federal direct student loans. In her first year, she can borrow $5,500. In her second year, $6,500, and any of the years following up to $7,500. Because you only get to borrow a certain amount in these direct federal student loans—which have much lower interest rates than Parent PLUS loans or private loans—it’s worth borrowing the max each year and accruing that interest rather than waiting and trying to borrow the full cost of college her third or fourth year, says Kantrowitz.
If you have other savings accounts you can draw from, Kantrowitz recommends setting aside $4,000 a year from such an account for your daughter’s college education so that you can take advantage of the American Opportunity Tax Credit.
With this credit, you get 100% of the first $2,000 you spend on tuition, fees and course materials paid during the year, plus 25% of the next $2,000. The credit is worth $2,500 off your tax bill. Also, 40% of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
The caveat: You will need to have a modified adjusted gross income of $80,000 or less, or $160,000 or less for married couples, a year to get the full benefit. If you earn more than $90,000 or $180,000 for joint filers, you cannot claim the credit.
You cannot use any of the funds from your 529 to qualify for the tax credit since that plan is already a form of tax-free educational assistance. If you do not have an additional $4,000 a year to put toward her education, you can also qualify for the credit by using the student loan amount she received—but just know that you may not be also able to claim the student loan deduction on that amount since you’ve already received a tax break on it, says Kantrowitz. (Right now you can claim both, but Kantrowitz says that could change in the future.)
After deducting any grant aid, her student loan sum, and the $4,000 from another savings account, pay the remaining education expenses with funds from the 529 plan.
“Under this plan it is likely your 529 will be exhausted after her third year of college, or sooner if you don’t put aside that additional $4,000 for the tax credit each year,” says Kantrowitz.
To make up the difference you’ll need to secure another loan. If you own a home, consider home equity financing before PLUS loans, since the latter currently carry a 7.21% interest rate and come with an “origination” fee of about 4.3% of the principal amount you borrow.
If you must take the PLUS, you might be tempted to try to lock in current interest rates by borrowing to cover the first two years’ worth of expenses. But you’d end up having to borrow more since she’ll be getting less federal loan money those first two years, and you’d have to pay two more year’s worth of interest. Even with possible rate increases, you’re still better off taking the PLUS loans in her last two years.
You have a lot of demands on your money—and not a lot of it. Here's what to do first.
The most financially challenging state of life is not retirement, it is early career.
That’s the time when your salary is still probably low, but you have the longest list of expenses: career clothes, cell phone bills, your first home furnishings, cars, weddings, rent—need I go on? You probably don’t have enough money to pay for all of that at once, unless your parents have set you up very well or you are a junior investment banker.
The rest of us have to make choices with our limited “discretionary” income. Here is a rough priorities list for newbies who have shopping lists that are bigger than their bank accounts.
First, feed the 401(k) to the match, not the max. If your employer matches your contributions, make sure that your paycheck withdrawals are high enough to capture the entire company match. That is free money. If you have enough money to contribute more to your 401(k), that is a good thing to do, but only if you’re able to cover other key expenses.
Invest in items that will improve your lifetime earning power. A good interview suit. An advanced degree. The right electronic devices and services for the serious job hunt.
Pay off credit card balances. Chasing those “balance due” notices every month will kill just about any other financial goal you have. If you’re carrying significant credit card balances, abandon all other extra savings and spending until you’ve paid them off, in chunks as large as possible.
Put money into a Roth individual retirement account. The younger you are and the lower your tax bracket, the better this works out for you. Money goes in on an after-tax basis and comes out tax-free in retirement. You can withdraw your own contributions tax-free whenever you want. Once the account has been in existence for five years, you can pull an additional $10,000 out, tax-free, to buy a home. It’s nice to have a Roth, and the younger you start it the better.
Save for a home down payment. Homeownership is still a smart way to build equity over a lifetime. New guidelines will once again make mortgages available to people who make downpayments as low as 3%. Even though interest rates are still at unrewarding lows, it’s good to amass these earmarked funds in a savings or money market account.
Pay down high-interest student loans. If you had private loans with interest rates over 8%, find out whether you can refinance them at a lower rate. If not, consider paying extra principal to burn that costly debt more quickly. Don’t race to pay off lower-interest student loans; the interest on them may be tax deductible, and there are better places to put extra cash.
Buy experiences, not things. Still have some money left? Fly across the country to attend your college roommate’s wedding. Take road trips with friends. Spend money to join a sports team, theater group, or fantasy football league. Focus your finances on making memories, not acquiring things—academic research holds that you get more happiness for the dollar by doing that, and you’ll probably be moving soon anyway.
Buy a couch. For now, make this the bottom of your list. Sure, everyone needs a place to sit, but there’s nothing wrong with living like a student just a little bit longer. If you defer expensive things for a few years while you put money towards all the higher priorities on this list, you’ll be sitting pretty in the future.
UPDATE: This story has been updated to clarify that Roth IRA holders can withdraw their own contributions at any time and do not have to wait until the account is five years old.
When it comes to student debt, it's not fair to blame students for being in over their heads.
The Brown Center on Education Policy at the Brookings Institution is on a mission.
Over the past several months, the center’s researchers have been working hard to reset popular perceptions about the existence of a student loan crisis and, perhaps, influence public policy as a result.
In the first of its reports (April 2014), the BCEP concluded that not only is the price tag for governmental student loan relief programs much higher than originally thought, but their existence presents an irresistible temptation for students to “engage in more risky behavior because they don’t have to bear the full cost of their actions.”
As such, the center urges policymakers to eliminate the forgiveness portions of the various relief programs to “reduce the potential for over-borrowing by requiring borrowers to eventually pay off their debt.” Doing so, the center’s researchers argue, would also dissuade low-income borrowers—whom they view as disproportionately benefiting from these programs—from attending high-priced schools.
In a follow-up report (June), the same researchers take this a step further by contending that broad-based policy actions on the part of the federal government are “likely to be unnecessary and are wasteful given the lack of evidence of wide-spread hardship”—a conclusion they base upon creative manipulations of Federal Reserve Bank of New York data and selective interpretations of macroeconomic factors and trends.
Three months later (September), the center published an update, in which the researchers turn up the heat by directly challenging what they characterize as the “often-hysterical public debate about student loan debt.” Selective FRBNY data is once again used, this time to bolster a contention that “households with education debt today are still no worse off than their counterparts were more than 20 years ago,”—a conclusion that’s based, in part, on halving the value of those loans on the dubious presumption that U.S. households are typically made up of two people who would be equally responsible for their repayment.
Most recently (December), the BCEP published what may be the capstone to the previous three reports. Its researchers found that more than half of all first-year college students seriously underestimate the extent of their education-related borrowing, which “may perpetuate popular narratives about crushing student loan burdens.” They also contend that after taking into account inflation and financial aid, “college is more expensive, but not to the extent it appears at first glance.”
As it happens, this latest view reinforces their previously articulated “unnecessary and wasteful” conclusion with regard to loan-relief programs, not least because “without knowledge of their financial circumstances, a student with a large sum of debt might be unprepared to compete for the jobs that would pay generously enough to allow them to repay their debt without having to enter an income-based repayment program.”
So to sum up the narrative the BCEP has evolved on this contentious subject, borrowers today are no worse off than those of the immediately preceding generation; tuition prices aren’t so out of whack as we’ve been led to believe; and not only are the government’s relief programs extravagant and pointless, but they also present a moral hazard.
In other words, to the extent that today’s students find themselves in over their heads, it’s their own fault!
Well, we are all certainly entitled to our own opinions. And from the hundreds of comments that are posted on articles discussing student loans, it appears that many agree with the BCEP’s conclusions—especially those who worked their way through school and repaid all their education debts over time, like me.
But that doesn’t mean that the Brookings’ point of view should go unchallenged, particularly when there is more information to consider.
Take for example, the fact that over the past 20 years, average higher-education prices have consistently outpaced the rate of inflation, average student borrowing has more than doubled, average aggregate borrowings have more than quadrupled, college-completion rates remain stuck at just north of 50%—and that’s for students who take six years to complete a four-year degree—and less than half of all loan payments are being remitted in accordance with the original terms of the underlying agreements (which means that more than half of all student loans that are currently in repayment are either delinquent or in default, have been granted temporary forbearance or were permanently restructured to facilitate repayment).
If the Brookings Institution is serious about providing “innovative, practical recommendations” that “foster the economic and social welfare, security and opportunity of all Americans,” not only would its researchers objectively incorporate all the available data, but their reports would also critically assess the personal-financial management implications of the higher-education industry’s revenue-based business model, the government’s easy-credit policies and the private sector’s loan-underwriting practices, which value creditworthy cosigners and the virtual impossibility of discharge in bankruptcy court over a borrower’s ability to repay his obligation.
As important, the institution would also vigorously explore the reasons for what is clearly an abject failure of financial-literacy education in secondary education and within college financial-aid offices that helped bring us to this miserable juncture.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.
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- How Student Loans Can Impact Your Credit
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Some good news for students of all ages this year.
Every year, there are innovators who come up with fresh solutions to nagging problems. Companies roll out new products or services, or improve on old ones. Researchers propose better theories to explain the world. Or stuff that’s been flying under the radar finally captivates a wide audience. For MONEY’s annual Best New Ideas list, our writers searched the world of money for the most compelling products, strategies, and insights of 2014. To make the list, these ideas—which cover the world of investing, retirement, health care, tech, college, and more—have to be more than novel. They have to help you save money, make money, or improve the way you spend it, like these three higher-ed innovations.
Best Help For College Grads
More borrowers can now cap their student loan payments, so that the bills eat up no more than 10% to 15% of income. Although these programs first got going a few years ago, they became a lot easier to access in 2014—enrollment doubled to 1.9 million in the 12 months before June 30.
One reason: The StudentLoans.gov site introduced a handy new calculator to quickly compare repayment options, as well as a one-stop application that allows borrowers to choose the plan with the lowest monthly payments.
Best Fast Path to a Degree
If you know the material in, say, Econ 101, should it matter whether you learned it sitting in a lecture, by taking a free online course, or by reading the books? More well-regarded schools are saying it shouldn’t—and that could help bring down the cost of getting a degree. The University of Wisconsin system now makes it possible to earn a bachelor’s by taking tests or submitting portfolios of your work.
The University of Michigan, the University of Texas system, and Purdue are also launching “competency-based” degrees. In the first year of UW’s program, one ambitious student aced enough tests to earn 33 credits in three months, at a cost of only $2,250.
Best New (and Returning) Free Courses
The number and quality of free online courses kept improving in 2014, offering everything from guitar lessons to “no-pay MBAs.” These are three of the most proven of the “massive open online courses,” or MOOCs.
A popular newbie in 2014: If Interstellar inspired you to learn about the cosmos, check out CalTech’s The Science of the Solar System, which has gotten five-star reviews on Coursetalk.com. As you would expect from a CalTech course, it’s challenging, according to the 2014 students. It’s being offered again through Coursera starting March 30, 2015.
Two favorites of the year: As computers become ever more essential to our jobs, programming has become a crucial career skill. But which language should you learn? And how can you learn it quickly and cheaply? MITx’s “Introduction to Computer Science and Programming using Python” teaches what has become the most popular programming language at colleges. Most MOOCs are plagued by high dropout rates. But among all the free courses offered by EdX, the MOOC platform for Harvard, MIT, and many other elite colleges, this three-year-old class is in the top five for number of students who have completed all assignments. The class is being offered again starting Jan. 7, 2015.
Even if you don’t plan to start a business yourself, odds are that you’re working for someone who is trying to be more entrepreneurial. And one of the most popular entrepreneurial gurus of the moment is Steve Blank, a tech entrepreneur who is one of the founders of the “lean startup” movement. Blank’s learn-at-your-own pace “How to Build a Startup” course has been sampled by about a quarter of a million students already, making it one of Udacity’s most popular.
Although college costs are still increasing, they're increasing at a much lower rate than they have in recent years. Interest rates and repayment for federal loans have eased as well.
About half of student loan borrowers underestimate the amount of education debt they have.
It seems some college students need to work on their reading comprehension. Or their vocabulary. Whatever the problem is, some students aren’t grasping the concept of loans: 17% of first-year students who have federal student loans responded to a survey saying they had no student debt, according to a Brookings Institution report.
There are scores of stories and reports about the difficulty borrowers have repaying education debt, and that’s a serious issue, but the statistics about borrowers’ understanding of their loans and the cost of college are much more troubling.
The report from Brookings “Are College Students Borrowing Blindly?” cites some shocking figures, based on two data sets. The first, a survey conducted in spring 2014, included responses from first-time, full-time freshmen who applied for financial aid at their college, a “selective four-year public university in the northeastern U.S.” The second is the most recent result of the National Postsecondary Student Aid Study, a nationally representative analysis of first-year, full-time undergraduates with federal loan information available in the National Student Loan Data System.
The data reveals that students are generally clueless about the costs of higher education and how they’re paying for it. Nearly half of students underestimated their debt loads by at least $1,000, with 25% of students underestimating their debt by $5,000 or more.
I’m in Debt? Really?
There are a lot of reasons students may not fully understand their student loan debt: Students may be confused about the different kinds of loans (like federal or private), their parents may have taken charge of figuring out their education expenses, they’re simply not keeping track of their finances, or they really don’t understand the fact that borrowed money must be repaid. There’s not really a good excuse, considering the students had to sign paperwork saying they’ll repay the loan as agreed.
The gap between perceived and actual student debt is potentially more troubling than the growing student debt load itself. Failing to understand the costs of college and how you’re paying for it sets students up for an unpleasant reality check and regret if they can’t afford the debt they incurred along their chosen career path.
Student loans are rarely discharged in bankruptcy, and failing to repay them has serious consequences on the rest of your financial life. Missing loan payments is one of the worst things you can do to your credit, and if you default on student loans, you may face wage garnishment and calls from debt collectors.
Consequently, a low credit score can leave you unable to secure other forms of credit at affordable interest rates, not to mention rent an apartment or get a job. To see how student loans and your other financial behaviors affect your credit score, you can review two of your credit scores for free every 30 days on Credit.com.
Ideally, you’re well prepared to handle your student loans when you enter repayment, but if you think your loan payments will be unaffordable, you have a few options. If you have federal student loans, you may qualify for a variety of student loan repayment and forgiveness options. If you have private loans, you may be able to refinance. At the very least, you should reach out to your student loan servicer to see if there’s any way to avoid defaulting on your education debt.
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'Four-year degree' doesn't mean what it used to
There’s been plenty of ink and pixels spent parsing the problem of student loan debt: Why it’s so high, who to blame, how to stop it and so on. But a recent study sheds light on a huge contributor to the problem that goes largely overlooked: Public college graduation rates, even at big flagships schools, are jaw-droppingly low.
A study conducted by nonprofit group Complete College America tallied up both state-level and national data on graduation rates at two-year and four-year public colleges, and the results are sobering.
Only 5% of two-year students actually graduate in two years. The picture is hardly better for four-year institutions, especially when you consider that the cost of obtaining a bachelor’s degree is significantly higher. Only 36% of students at flagship public schools, and 19% of students at satellite and regional campuses, are able to walk out of the gates, diploma in hand, after four years.
“[We were] surprised at how pervasive the problem of time to degree has become at all public higher education institutions,” says Bruce Vandal, the group’s vice president. While two-year schools tend to attract more older, lower-income and first-generation students — all demographics more likely to be part-time students — Vandal says the issue goes far beyond that. “We did not expect flagship institutions and more selective public institutions to also have low on time graduation rates,” he says.
The numbers paint a clear picture showing that school administrators and policymakers, not to mention students, now consider a four-plus year timeframe to be the norm.
To some extent, Vandal says, this is a product of student error. Kids might not know what they want to major in when they first get to college and wind up taking a bunch of classes that don’t advance them towards the major they eventually choose. There also are a
But blaming a bunch of 17- and 18-year-olds for not being able to navigate the higher education system essentially on their own isn’t the answer. Vandal says there are plenty of things schools and states can do to make students better-informed consumers of the educational services they receive.
Some schools are experimenting with what Vandal calls a “guided pathways system:” Students have to pick a broad category — say, Health Sciences, for example — right away, then they get a year to narrow down their specific field of study.
“Another problem is that too few students enroll in the requisite 15 credits a semester that are necessary to graduate on time,” Vandal says. Students become eligible for “full time” financial aid while taking 12 credits a semester, and this mismatch adds up.
“For four-year students, registering for only 12 credits a term automatically puts them on the five-year plan,” Vandal says.
This has a big impact on students’ budgets and, ultimately, the debt loads they’ll carry with them for the first decade of their adult lives. “Once students’ time to degree exceeds four years, the costs to attend college increase and debt levels rise dramatically,” Vandal says. Every extra year of college for two-year degree seekers costs an average of $15,933 more. For four year degrees, it’s even higher: $22,826 for every extra year.
After four years, grants and scholarships may expire, and the savings of students and their families are more likely to be depleted, Vandal says, forcing them to rely more heavily on loans to complete their degrees.
“Reducing the time to degree and credits to degree for students will dramatically decrease student loan debt,” he says.
A student loan expert explains why there's hope for a parent saddled with student loan debt from two kids.
Brent Strine, 65, sent a blog comment to us describing what he thought was probably an impossible situation, and he despaired of ever being able to get out of debt. He wasn’t asking for help so much as describing a sense of hopelessness. Here’s what he told us:
I have 45k in parent loans from two children who cannot help me pay on them. Every time I defer them it costs over 1k added to the principal. I am 65, our (total household income) is 28k . . . (We have) no savings, no retirement plans or funds. Seems the only way out of debt is through the grave.
When we contacted him, he quickly noted that he feels grateful for his home and family, “and I am not in any way a ‘victim.’” He had deferred the loans when his wife was hospitalized after a serious car accident and when he had cancer surgery. He continues to work full time as a custodial supervisor, though he plans to retire in May 2015 because of some physical limitations. At that point, he wants to find part-time work. He was clearly worried about his debt, though.
He gave us the balances of his loans, down to the penny. And though he knew exactly how much he owes, he hadn’t a clue about how he could possibly repay it. He wondered if there’s some way he can get lower interest rates — he has several loans, $37K total, with rates of 8% or 8.5%. (The rest of the loans have much lower interest rates.)
We spoke with Joshua Cohen, “The Student Loan Lawyer,” on Strine’s behalf. The good news is Strine probably need not worry about unaffordable payments or high interest rates. Because he has federal Parent PLUS loans, he — and not his children — is on the hook for the debts, Cohen noted. And although Strine won’t be able to get lower interest rates, it won’t matter, said Cohen.
That’s because Strine’s $28K income should make him eligible for a repayment plan based on the borrower’s income. Cohen said a family of two with an adjusted gross income (reported on federal tax return) of $28K would have a monthly payment of $205. However, when we reached out to Strine, he told us his most recent tax return had an AGI well under $20K. That would result in a payment of just $71 per month, and possibly even less, Cohen said.
“The plan I’m talking about is called Income-Contingent Repayment (ICR) — the only income-based plan allowed for Parent PLUS loans,” Cohen wrote in an email. He had more good news for Strine: “It comes with 25-year forgiveness, which means if you live to 90, your loans will be forgiven. If you pass away before then, the loan goes with you — it will not attach to your estate.
“Bottom line, you can survive this loan,” Cohen said. “It would have been nice if the servicer gave you this information. After all, that’s what us taxpayers are paying for — to help borrowers stay out of default and continue paying.”
Student loans have an impact on your credit, for better or worse. Making arrangements with the servicer for payments you can afford can help you stay afloat financially, as well as help your credit standing — by making the payments on time and as agreed. You can see how your student loans are affecting your credit for free on Credit.com, where you can get two free scores updated monthly.
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This article originally appeared on Credit.com.
Some of them will surprise you
Most college students pick their major based on their talents and their interests, not on how easily that major can help them pay down their student loans. Maybe it’s time to rethink that.
A new study breaks down exactly how hard it is for former students to pay off their student loans based on what their chosen major. While some of the results are predictable, the research sheds new light on exactly how tough it can be for new grads in certain fields. The Brookings Institution’s Hamilton Project crunched the numbers on more than 80 different majors to determine how much graduates typically earn right out of school as well as a decade later, and how that affects their ability to pay off their student loans.
At the median, someone with a bachelor’s degree earns $27,000 right out of school, but some majors make considerably less, with a number earning under $20,000. “In the first year of the career, when earnings are at their lowest, graduates from several majors in the arts and humanities would need more than 20 percent of their earnings to service their loans,” the report says.
The list of majors who have to put the highest share of their income towards their loans in the first year after graduation is an eclectic one. “Graduates in drama and theater face payments of 24% of their earnings during the first year of repayment,” the study says. In addition, those with degrees in health and physical education, civilization, ethnic studies, composition, speech, fine arts and nutrition and fitness studies pay the highest percentage of their earnings towards student loan repayment in their first year out of school.
The vast majority — 66 of the 81 majors examined — will have to funnel more than 10% of their first-year earnings towards their student loans. Even grads with degrees in business and math initially have to spend 12% or more of their earnings servicing their debts.
The study also takes a look at how fast graduates’ income rises after graduation. Some of the majors with the lowest initial starting salaries see the fastest increase, largely because starting salaries are initially so low. Many graduates, even those who start out paying a high percentage of their income towards their debts, see that percentage fall quickly. “Earnings grow quickly for graduates of almost every major and especially so for those who start with the lowest earnings,” the study says. By the sixth year of a 10-year payment plan, only a handful of majors are paying more than 10% of their income in debt payments.
Those low incomes right after graduation are still cause for concern, though. “A key problem with the current college financing system is that debt payments are often fixed, while for many majors, earnings are low in the initial years following graduation,” the study’s authors point out. “This mismatch can lead to a substantial financial burden on young workers.”
Is there a solution? The study makes some recommendations around expanding the use of income-based repayment programs, but for now, students might want to consider majoring in computer science, nursing, operations and logistics, or any kind of engineering: People who come out of college with these majors have to dedicate the smallest percentage of their income upon graduation to their student loans.