Lower Variable Rates May Cost More Than Fixed Rates
In some cases a private student loan or non-education loan will offer a variable rate that is initially lower than the fixed rate on a federal education loan. But these variable rates have nowhere to go but up. The variable rates may remain low for the next few years, but will start increasing as soon as the Federal Reserve stops suppressing interest rate changes. The interest rates will then start increasing by about 1.5% per year until they return to the neighborhood of interest rates from before the credit crisis. To calculate the equivalent fixed rate for a variable rate loan with a 10-year term, add about 4 percentage points to the interest rate. So unless the borrower plans on paying off the loan in full in a few years, a variable-rate loan may ultimately cost more than the fixed-rate federal education loans, despite the nominally lower interest rates.
Signs of Over-Borrowing
Needing to borrow beyond the Federal Stafford loan limits is often a sign of over-borrowing, regardless of whether it involves a Federal Parent PLUS loan, private student loan or non-education loan. Total student loan debt at graduation should be less than the expected annual starting salary. If total student loan debt is less than the annual income, the borrower will be able to repay the debt in ten years or less. Otherwise the borrower will struggle to repay the loans and may need an alternate repayment plan, like extended repayment or income-based repayment, to afford the monthly loan payments. Parents should also be careful about the amount of debt they incur. Parents should borrow no more for all their children than they can afford to repay in 10 years or by the time they retire, whichever comes first.
Risks of Education Financing
There are also a variety of serious risks associated with borrowing for a college education. Federal and private education loans are almost impossible to discharge in bankruptcy. The federal government has very strong powers to compel repayment of defaulted federal education loans, including garnishment of up to 15% of the borrower's income and Social Security benefit payments and the offset of federal and state income tax refunds (and state lottery winnings). The federal government can block renewal of a professional license. Borrowers who default on federal education loans are ineligible for FHA and VA mortgages and may not enlist in the military. Private student loans may also garnish wages and seize assets, but only after suing the borrower and obtaining a court judgment.