Edward A. Zurndorfer, Certified Financial Planner

There is bad news for federal employees whose children will be attending a college this fall. The cost of attending several colleges or universities -- this includes tuition, room and board and other higher education fees -- for the 2010-2011 academic year could be approaching $50,000.

While the cost of attending most colleges and universities will be less than $50,000 and scholarship money is available for qualifying students, many employees with children attending college this upcoming academic year may find it difficult to pay their children's college expenses solely from their salaries and savings. To fill in any gap between what their children's college education will cost and what a parent can afford to pay, a parent and/or student will likely have to borrow in the form of student loans. But employees with children attending colleges or universities this fall should discover that as a result of a recent law change, the student- and parent- loan borrowing process has changed, making the process easier and most important cheaper for both parents and students .

In the past, many college students and their parents who applied for student loans did so through the Federal Family Education Loan (FFEL) program. Since most colleges and universities participated in the FFEL, students applying for student loans through the FFEL would receive federally guaranteed loans through banks or other lending institutions. Colleges that did not participate in FFEL instead participated in the federal government's run Direct Loan program with loans coming directly from the federal government.

As an unlikely part of the new health care legislation (the Patient Protection and Affordable Care Act of 2010) that was passed into law in March 2010, effective July 1, 2010 all lending programs from the bank-based FFEL will be transferred to the Direct Loan program. Private banks will no longer market government-backed loans to students and all federal government-backed student loans will originate in the Direct Loan program.

Any college or university that wants its students to have access to federal government-backed student loans is required to participate in the Direct Loan program. But the loan process will be streamlined, resulting in less confusion and an easier process to obtain loans with lower interest rates. In addition, the repayment rules will be better for student borrowers for loans made after June 2014.

Perhaps the best result of the new law will be that students will not have to "shop around" for a student loan with the lowest interest rate and best loan repayment terms as they have in the past. The FFEL program required that the student and parents had to deal with different "entities" - including a lender, a loan guarantor, and a loan service. Many families had to decide which lender to use. Some families ended up choosing a lender from the college's "preferred list". Unfortunately, in some cases the lenders on the college or university's "preferred list" did not offer the most competitive rates and terms resulting in higher than expected borrowing costs for parents and students. By eliminating the "middleman" and using the Direct Loan program, the Congressional Budget Office estimates that the government will save $68 billion over the next 10 years

Parents and students will nevertheless have to go through the same application process for their student loans as they have in the past. They will have to fill out the Free Application for Federal Student Aid (FAFSA) form (application process may done online at http://www.fafsa.ed.gov) if they hope to qualify for Stafford loans. Unsubsidized Stafford loans, which come directly from the federal government, will be made to students with no credit checks. These loans are available to any student no matter which college or university a student attends - this includes both private and public colleges and universities. For the academic year 2010-2011, unsubsidized Stafford loans come with a fixed interest rate of 6.8 percent, the same rate on unsubsidized loans during the 2009-2010 academic year. Subsidized Stafford loans, which have lower interest rates and easier repayment terms, are based on financial need. Most students will likely receive unsubsidized Stafford loans.

Unsubsidized Stafford loans have academic year and lifetime borrowing limits. Freshmen can borrow no more than $5,500, sophomores can borrow no more than $6,500, and junior and seniors can borrow no more than $7,500 per academic year. There is also a $31,000 cap on lifetime borrowing.

Once the FAFSA is completed and accepted, the student or parent will inform the college or university that they want access to a federal education loan. The college or university will provide a Master Promissory Note for the parent or student to complete and sign. The loan will then be funded through the federal government.

For most students, the cost of a four-year college or university education will far exceed the $31,000 lifetime cap on Stafford loans. Additional loans may therefore be necessary. Through the Direct Loan program, there are the Parents' Loans for Undergraduate Students (PLUS). PLUS loans are for parents of undergraduates or for graduate students. A parent or graduate student may be eligible to receive a PLUS loan that can fund the difference between the cost of attending a given school and the amount of financial aid the school offers the student. For example, if Jeff attends a university where the total cost of attendance - this includes tuition and fees, room and board, and miscellaneous fees - during the 2010-2011 academic year is $45,000 and Jeff gets a $20,000 financial aid package from the university, then Jeff's parents can borrow up to $25,000 using a PLUS loan.

But unlike unsubsidized Stafford loans, PLUS loans require borrowers to demonstrate credit worthiness. In fact, to qualify for a PLUS loan a borrower may not have an adverse credit history. A potential PLUS loan borrower must not have had any derogatory elements such as a personal bankruptcy filing or a home foreclosure in the prior five years.

PLUS loans have a fixed 8.5 percent interest rate in the FFEL program, while PLUS borrowers through the federal government's Direct Loan program have a fixed interest rate of 7.9 percent. This means that all PLUS loans issued after June 1, 2010 will be through the Direct Loan program and parents will be paying less in interest for their PLUS loans. Note that a PLUS borrower who "barely" qualifies under the PLUS loan borrowing requirements will pay the same 7.9 percent interest rate as a potential PLUS borrower with a superlative credit score.

Would there be any circumstances in which a parent would choose a private loan rather than a federal PLUS loan? In some cases, a parent prefers that their children do the borrowing through a bank-funded private - even if the parent has to co-sign for the loan. In this way, the student will be the one who is primarily responsible for repaying a student loan.

There may also be parents who want to borrow money from a bank in which they have a "personal" relationship in order to pay for their children's higher education expenses.  If parents are creditworthy, they may get a better interest rate than the 7.9 percent interest rate currently charged on PLUS loans. Private student loans usually have variable interest rates, with rates currently ranging anywhere from four to 12 percent. Some banks will reduce their interest rate for borrowers who pay promptly and who use automatic payments from their bank accounts. On the other hand, some parents may not qualify for PLUS loans because of poor credit history. These borrowers may be able to obtain a private student loan by agreeing to pay double-digit variable interest rates.

The recent changes to the student loan program will hopefully ease employees' anxieties about being able to pay for the cost of their children's higher education. With these changes, employees who may have been focusing on saving for and paying for their children's higher education may now instead focus on saving sufficiently for their retirement. For most federal employees, maximizing contributions to the Thrift Savings Plan and to IRAs should be a primary goal in order to sufficiently save for a retirement that could last for as many as 30 to 40 years. On the other hand, a college education usually lasts for a far shorter period of time and with more funding options.

About the Author

Edward A. Zurndorfer is a Certified Financial Planner, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD.  He is an instructor at federal employee retirement seminars throughout the country for the National Institute of Transition Planning, Inc. and writes numerous columns and books on federal employee benefits.

Posted on 7/15/2010

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