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Will Refusing Loans Increase College Grants in the Financial Aid Package?

Mark Kantrowitz

June 21, 2010

I filled out the FAFSA in March and recently received a letter that offered me a $3,500 unsubsidized Stafford loan. I did a little research and found out I would have to pay interest on interest. I’m thinking about declining it and mailing it back to the school I attend. Will I be offered any other financial aid or is this all I’m going to receive if I send it back declining it? I can’t afford to pay back that much money and don’t want to go into debt. — Heather K.

If you decline your student loans, the college will not increase other forms of financial aid to compensate. You will simply have to pay the $3,500 from your own resources.

Nobody wants to go into debt, but the reality is that college means debt. Almost seven-eighths (86.3%) of students at four-year colleges who apply for federal student aid graduate with student loans, an average of $24,651.

Borrowers of unsubsidized Stafford loans may defer making payments until six months after graduation. However, the interest continues to accrue and will be capitalized. Capitalization of interest adds it to the loan balance, increasing the size of the loan and ultimately leading to the paying of interest on interest. For example, assuming an unsubsidized Stafford loan for a college freshman is disbursed in two disbursements, a total of $283 in interest will have accumulated for every $1,000 borrowed by the time the loan enters repayment. If the borrower chooses to capitalize this interest instead of paying it, the monthly loan payment will increase by 28% and the total interest paid over the life of the loan will increase by $108 for every $1,000 borrowed, assuming a 10-year repayment term. With a 20-year repayment plan the total interest paid over the life of the loan will increase by $236 for every $1,000 borrowed.

It is always better to pay at least the interest during the in-school and grace periods. This yields a lower loan balance at graduation and will save a lot of interest over the life of the loan. Because of the lower loan balance, you will be able to repay the loan quicker, saving you additional money. Increasing the monthly payment by 25% will cut 2.6 years off of a 10-year repayment plan and reduce the total interest paid by almost 28%. On a 20-year repayment plan it saves 6.7 years and reduces the interest by more than 37%. On a typical student loan avoiding interest capitalization will save thousands of dollars in interest.

Of course, an even better approach is to minimize the debt by finding a way to cut your college costs. Live like a student while you are in school so you don’t have to live like a student after you graduate.

My son is 23 and will be 24 by December 31. He had more than $10,000 in unemployment compensation last year. My daughter is 22 and will be going to college full-time. I filled out the parent’s portion of her FAFSA since she was considered a dependent student. Would it help my son if I fill out the parental information section of his FAFSA? Would it bring down his EFC because his sister is also going to college? — Ohana J.

Since your son will be age 24 by December 31 of the award year, he is automatically independent. Even if you complete the parental information section of his FAFSA it will be disregarded and will not affect his EFC.

If your son is still unemployed, he should ask the college to use professional judgment to disregard his unemployment compensation. The US Department of Education has issued a Dear Colleague Letter to college financial aid offices allowing them to zero out the income of independent students who are receiving unemployment benefits during the current economic downturn. This could have a significant impact on his EFC.


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