Tara Unverzagt September 28, 2018 No Comments

Cost of College Can Be More Stressful Than a Final Exam!

College is supposed to be “the best four years of your life,” filled with long hours at the library, meeting lifelong friends, and creating experiences you’ll have for the rest of your life. Simultaneously, it has also become “the most expensive four years of your life,” and, for most people, making decisions about financing your education and the inevitable debt begins at the ripe old age of 18. As a high schooler, you’re faced with one of life’s biggest decisions at a time when you’re still developing. Trying to decide what you want to do for the rest of your life can often seem daunting, but, nonetheless, you must make a decision. Deciding which school to go to and what to major in will have countless impacts on you for years to come.

As a recent graduate of Case Western Reserve University in 2016, I have found there is no worse feeling than having debt lingering over my shoulder, especially at the age of 22. Having learned from my mistakes–and my successes–I hope that this article will help those of you who are preparing yourself or a loved one to go to college. If I could go back and speak to 18-year-old Stuart, I would share some thoughts that I’ll cover in a series of articles starting with this one.

The Different Types of Student Loans

Student loans come in many different shapes and sizes. Before choosing any of them, you need to understand the differences among all of the options that you could be presented. They break down into two categories: federal and private.

Federal loans are offered through the U.S. Department of Education as either Direct Subsidized, Direct Unsubsidized, and Parent PLUS. Subsidized loans come with slightly more favorable terms but are strictly provided to students who meet the requirements of being in “financial need.” The main benefit to Subsidized loans is that they are offered at a low-cost and fixed rate, with the interest being paid by the government while you are in school, hence the term “subsidized”.

Unsubsidized loans are available to everyone and also come low-cost and at a fixed rate.  The key difference, however, is that the government does not pay for the interest that accrues on the loans while you are in school, which means you are on the hook for a larger bill.

Parent PLUS loans are available to parents who are paying for their dependent children’s college costs. Because they come with higher interest rates, students and parents need to utilize subsidized and unsubsidized loans before considering taking out a Parent PLUS loan.

On the other hand, private loans are taken out from banks, certain states, the college or university, and other non-bank financial institutions. The rates and repayment terms vary by institution, personal credit scores, income level, debt-to-income ratio, etc., very similar to any other loan you would take out from a private institution. Due to the lower costs and repayment terms of Federal loans, a general rule of thumb is to explore those first and then pursue Private loans after you have shopped them, to ensure that you get the best possible rates and terms.

Best Practices for Loans

Understanding different types of loans is important but equally as important is knowing how to utilize them. Obviously, there are many different factors that will be in play, such as money or investments that can be used, eligibility for financial aid or scholarships/grants, and ability to work while in school, so each individual’s situation will be different. Your best option is to sit down with an expert and make your decision based on your personal situation, but I will lay out a general blueprint that you can follow when you are considering loans.

If you qualify for Subsidized loans, it is of utmost importance to make sure you utilize these first, followed by Unsubsidized loans. Following those, you can consider private loans up to the amount that is needed to cover the total costs of attendance.

Note that if you don’t use a Direct Loan one year, you are not allowed to go back and reclaim it for the current year–they are very much “use it or lose it”. A common mistake people make is failing to budget their resources for all four years and running out of resources the final years and, consequently, being cornered into taking more expensive loans.

If, for example, you have $20,000 saved and allocated for costs of attending, you’re better off allocating $5,000 per year to tuition from a 529 account in order to maximize the number of Direct Loans that you are eligible for. Below is a chart that shows how much in Direct Loans you are eligible to receive per year for an undergraduate student who is still a dependent of his or her parents.

 

$5,500 total, no more than $3,500 Subsidized $6,500 total, no more than $4,500 Subsidized $7,500 total, no more than $5,500 Subsidized $7,500 total, no more than $5,500 Subsidized
Year 1 Year 2 Year 3 Year 4

Considerations When Picking a College

There is absolutely nothing simple about college planning, and, unfortunately, understanding the types of loans is only one piece of the puzzle. Deciding which college to attend goes beyond just a school ranking, location, major, etc. For best college planning, you must analyze all of your and/or your child’s financial and academic information to determine eligibility for need-based and merit-based financial aid, which can then be referenced against a list of schools to maximize scholarships. In addition, it’s important to understand the differences among schools and how they award financial aid.

The sooner you start planning for the cost of college the better. For parents, spending time planning when your children are young, picking the right school when they are in high school, and planning how you will fund each year can reduce the amount you may need to borrow and the types of loans you have access to.

Tara Unverzagt April 4, 2016 No Comments

Use Debt to Your Advantage

Debt has fueled much of the growth in the world over the last four decades. Debt has made many business owners, investors, and individuals wealthy. But debt has also been the ruin of many businesses, investors, and individuals.

The “final exam” of my MBA involved a business simulation. Each study group was tasked to run a business manufacturing hairdryers. My study group was mostly made up of bankers. When our door shut at the start, the bankers immediately said, “We need to get a line of credit.” I said, “We’re starting with a lot of available cash.” They explained that bankers only loan you money when you have money. At some point down the road, we may need money, but we should secure it in the beginning. That 10 minutes was more valuable to me than the two years that led up to it. Indeed, “down the road” the hairdryer market was booming, but we didn’t have enough cash to build a new plant. That line of credit provided the opportunity to grow our business. Our study group ended with millions of dollars more than any other study group. We had that line of credit right when we needed it while the others were just starting to negotiate with the banks.

This was a lesson in how debt can make you wealthy. The other side of that coin occurred as the housing boom went bust in 2008. There were a lot of people who borrowed money to buy a house, but didn’t have the funds to pay the debt. They lost their house and their wealth.

Debt helps magnify your return. If you want to buy a house, most people can purchase a bigger house with a loan than if they only used savings to purchase the house. If the value of that house goes up, there is a larger gain on the larger investment. But if the value of that house goes down, there is a larger loss.

So how do you use debt to your advantage? As the bankers in my MBA study group pointed out, you will only get debt when you have money. The more money you have, the more debt you will be allowed to carry. If you think like a banker, and only incur debt that you can pay off, you can use it to your advantage.

You can’t predict what’s going to happen to the housing market in the next 2-5 years, but the longer you are in the housing market, the more likely you are to see the value grow above what you invested. If you plan to stay in the housing market for the long haul, it’s fine to incur debt to purchase your home. But make sure you have enough funds to pay the mortgage for 6-12 months, even if you lose your job. This should be part of your Emergency Fund. If you don’t have enough savings to make future mortgage payments, you may find yourself in the position that so many people did in 2008 and risk losing your home.

When you buy a car, you do not typically expect it to increase in value. As a matter of fact, as soon as you drive a new car off the lot, it loses value. Buying a car with debt increases the cost of the car and therefore increases your loss. If you have a 10%, five year loan on your $20,000 car, you are really paying $25,500 for the car. In addition to the decrease in the value of the car, you are losing an extra $5,500 from interest payments. Many people lease a car instead of buying. Keep in mind this is just building the loan costs into the price of the car. Typically it’s easy to hide higher loan costs in the “low” monthly payments of a lease agreement. The more expensive the car, the more you lose in value and interest paid.

In order to sell more cars, dealers often offer 0% loan deals. This can be a way of using debt to your advantage. If you can get a 0% loan for $20,000 and then invest that money in a bond giving you 4%, you win. Make sure you have the $20,000 to pay off the loan. If the 0% interest is only for a limited time, pay the balance as soon as the interest rate goes up. Typically, if you miss a payment, you will pay high fees and/or the interest charges. So make those payments.

Bottom line, you can use debt to make money, but you can also lose money with debt. Follow some basic guidelines to use debt to your advantage.

  • Make sure you have the cash to pay the debt on time. For long term debt, have enough in cash to make payments for 6-12 months.
  • Use debt to increase your income, like paying for college tuition, but not for consumables like going out to eat or a nicer apartment.
  • Use debt when you can invest those funds at a higher return or in a business that can make more income than the cost of the debt.
  • If the item you purchase is not an investment that can increase in value, pay cash.

Debt always increases risk, but the risk can be managed if debt is used wisely.

 

All information provided is general in nature and not meant to be advice for you in particular. If you’d like to know more about how this topic relates to your situation, contact me at tara@southbayfinancialpartners.com