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Ask Kantro: Limit Total Student Loan Debt to Less Than $10,000 per Year to Avoid Overborrowing

I have twin daughters going to college in the fall. The annual tab (for both girls) after scholarships will be $58,000 in loans per year for four years. We have saved $47,000 for the first year and anticipate being able to save about $12,000 per year to apply towards payments over the three remaining years. This leaves us looking for loans to the tune of $145,000. Is there a particular strategy or any combination of specific loans you recommend to minimize interest accrued. Any other recommendations would also be sincerely appreciated! — Patrick P.

While your willingness to sacrifice for your daughters’ college education is commendable, the amount of debt you are considering is excessive. More than 95% of all undergraduate students will graduate with less education debt.

You should seriously consider sending your daughters to a less expensive college, where cumulative education debt at graduation will be at most $45,000 per daughter (and preferably a lot less). There are many good colleges where a motivated student can get an excellent education without mortgaging her future.

As a general rule of thumb, a student should never borrow more than her expected starting salary for her entire college education. If she borrows more than that, she will be at high risk of defaulting on her loans, and will have no choice but to use an alternate repayment plan like extended repayment or income-based repayment to repay the debt. This means she will be in debt for the majority of her working life and will still be repaying her own student loans when her own children enroll in college.

If you insist on investing in more college than you can afford, here are a few tips for reducing your borrowing costs:

1. Prefer subsidized loans over unsubsidized loans, since the federal government pays the interest on subsidized loans during the in-school and grace periods. The interest on unsubsidized loans is the borrower’s responsibility.

2. Pay at least the interest on unsubsidized loans while the student is in school. The interest on unsubsidized loans may be deferred by capitalizing it. But capitalizing interest increases the size of the loan by adding the interest to the loan balance. For example, capitalizing the interest will add more than $20,000 to your debt by the time your daughters graduate. Paying the interest along the way will mean a lower loan balance at graduation, so you won’t be paying interest on interest. A lower loan balance will allow you to pay off the debt sooner.

3. Prefer lower cost loans. This means loans with lower interest rates, not loans with lower monthly payments. Lenders can manipulate the monthly payment by increasing the term of the loan. For example, a $20,000 federal Stafford loan with a 6.8% interest rate and a 10-year repayment term has a $230 monthly payment, while a $20,000 private student loan with a 10% and a 20-year repayment term has a $193 monthly payment. The private student loan might seem to be more affordable because of the lower monthly payment, but the total payments on the private student loan will be $46,323 compared with $27,619 on the federal Stafford loan. When comparing loan payments on different loans, always use identical loan terms to get an apples-to-apples comparison.

The Stafford and Perkins loans have lower interest rates than the Parent PLUS loans, so a student should exhaust her eligibility for federal student loans before her parents borrow from the Parent PLUS loan program. This will save her family thousands of dollars in interest. (The unsubsidized Stafford loan and the Parent PLUS loan are available without regard to financial need, so you don’t need to be poor to qualify for these loans.) Other types of debt, such as home equity loans and private student loans will generally be more expensive over the life of the loan. We are currently in an unusually low interest rate environment. The variable rates on non-federal loans might be lower than the fixed rates on federal education loans if you have excellent credit, but these variable rates are likely to increase significantly over the next few years.

Don’t forget to claim the Hope Scholarship tax credit, which will save you a little money at tax time on your college costs.

My parents are in a financial bind and can’t get a loan for my school. They also can’t co-sign for a loan. I can’t get anybody else to co-sign either. What are my options? I need another $12,000 to $15,000 after my aid award. — Eric C.

Federal education loans do not require cosigners, so you must be talking about private student loans. Students should always borrow federal first before turning to private student loans. Needing to borrow private student loans is often a sign of overborrowing, as is borrowing more than $10,000 to $12,500 a year total, including both federal and private student loans.

These days more than four-fifths of all students will need a cosigner to obtain a private student loan. Even students with good credit will need a cosigner. Only students who have excellent credit will be able to obtain a private student loan without a creditworthy cosigner.

If your parents have been denied a Parent PLUS loan because of an adverse credit history (or there are other unusual circumstances that preclude them from borrowing a PLUS loan), the college can grant you the higher unsubsidized Stafford loan limits available to independent students. These limits, however, are only $4,000 higher during the freshman and sophomore years in college and $5,000 higher during the junior and senior years. You could try working part-time during the school year and full-time during the summer to earn the rest, but you may be better off switching to a less expensive college.

Ask Kantro is written by Mark Kantrowitz, an expert on paying for college and publisher of FinAid.org and FastWeb.com, the leading free web sites for information about student financial aid, student loans and scholarships. Write to Ask Kantro at AskKantro@FastWeb.com.

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