Loans 101: The Education of a CPA Parent
Michael J. Knight
help is available these days in planning for children’s
college education: financial assistance centers at colleges,
websites (mostly unnavigable and unable to answer questions
that vary from the script), and telephone operators. Saving
early, using home equity loans, scholarships, IRC section
529 plans are tried-and-true action plans to avoid college
funding destitution. But there is much more.
article in the Boston Globe talked about Sallie
a government-sponsored lender of education funding. I called
the toll-free number, and after 10 minutes of giving information
to a very helpful and knowledgeable person, I was approved.
“Parent (PLUS)” loan that I qualified for was
straightforward. I borrowed money to pay the tuition; the
interest rate, fixed for one year starting July 1, 2003,
was 4.22%. I was so excited that I told other fathers about
it, amazed that none of them had heard of the program. One
father followed up, but soon was asking, “Why didn’t
you tell me about the points that must be paid on the loan?”
He said he had talked to three different people at Sallie
Mae who gave him two different answers. Several phone calls
confirmed that he was right: The Parent (PLUS) loan carries
a 3% fee paid to the department of education.
days after Sallie Mae preapproved me for a Parent (PLUS)
loan, a postcard arrived instructing me to call the indicated
telephone number to reconfirm the process. In so doing,
I was told that if I paid the loan back on time for 48 months
the interest rate would be lowered by 2%, which they had
not told me earlier.
the organization that sent the postcard, Next Student, is
not part of Sallie Mae, but a competitor. Parent (PLUS)
is a federal program open to all lenders. I realized that
I had signed two promissory notes—one to Sallie Mae,
one to Next Student.
(PLUS) Menu 1: 10-Year Plan
(PLUS) loans are open to all parents of college students,
based on credit history; they are not need based. When an
applicant is qualified, the lender coordinates with the
school’s financial aid office to determine the exact
amount of the loan. Once the final payment to the college
for the year is made, the repayment cycle of the program
begins (generally 60 days after final payment to the college).
The basic repayment period is over 10 years. Assuming the
student has a $5,000 scholarship, the financial aid office
estimates costs of $30,000, and the interest rate is 4.22%:
monthly payment due February 1 (assuming first payment December
1), estimated over 10 years, comes to $263.41 per month.
Over four years, the payments would be as shown in Exhibit
the exhibit shows, the borrower can elect to pay interest
only. In this example, interest-only monthly payments would
be $90.55, compared to $263.41 for a 10-year payoff of the
principal and interest. The interest-only election can be
made for the years the student is in college. Because no
principal would have been paid, monthly payments will be
higher in years 5 though 10 as the loan is paid off (assuming
the rate stays at 4.22%, monthly payments beginning in year
5 would be $1,621.80 for 72 months).
way to repay the loan is to request forbearance, which is
the term Parent (PLUS) uses to describe a request to pay
nothing while the child is in school. The interest is added
to the principal, resulting in a bigger loan to repay and
higher monthly payments once repayment begins. Assuming
the same circumstances, the payments over the first four
years would look like Exhibit
with 72 months remaining on the 10-year schedule (120 months
– 48 months deferred), the parents will begin repaying
$114,337. The monthly payment for this (assuming the 4.22%
rate) is $1,800.30.
(PLUS) Menu 2: 30-Year Plan
option, called the Federal Consolidation Loan Program, provides
the same three methods of payment described above, but over
a longer term. The rate is fixed based on an average of
the rates on the loans received plus 1/8 of a percent. Assume
that the same $25,750 as above is borrowed each year at
rates of ranging from 2% to 8%, for an average rate of 5%
(20% divided by four years). If the loans are consolidated,
the interest rate will be 5.125% (5% + 1/8%), fixed for
the term of the loan. The term of the loan is based on the
total amount owed based on the following table:
at the end of four years the amount owed is $103,000 ($25,750
x 4), amortized over 30 years at 5.125%, the monthly payment
would be $560.82. This example assumes that the borrower
paid the interest during the four years of college and financed
the $103,000 after graduation, as demonstrated above. The
other two options are also available: interest plus principal,
or forbearance (no payments). Using the forbearance numbers
from the 10-year plan would produce $114,337 at 5.125% for
30 years. The payments would be $622.55 monthly. To confuse
the situation further, the consolidation feature can be
elected at any time, year 1, 2, 3, or 4.
loans are given directly to students at rates that are more
favorable than Parent (PLUS) loans, but for the same favorable
term length. The trade-off is that students can borrow only
lower amounts. The Stafford loan rate while the student
is in school is based on the 91-day T-Bill + 1.7%. As of
July 1, 2004, the rate for the year was 3.1%, significantly
better than the Parent (PLUS) loan rate of 4.22%. The Stafford
loan interest-rate cap changes every July 1 as the base
rate changes, and is currently 8.25%.
amounts a student can borrow are as follows:
same three payment options are available to the student
while in school as to the parent in the Parent (PLUS) program:
Payments of interest and principal from inception over
Payments of interest only (interest paid quarterly, not
No payments until six months after school ends.
Stafford loan does not allow for payments unless the student
elects to make payments. When the student begins payments
after school, interest is charged using a repayment index
of the 91-day T-Bill rate plus 2.30% (2.79% for July 2004).
If the student decides to consolidate loans, the rate can
be much more favorable than the Parent (PLUS) loan.
Stafford loan, whether interest is paid or added to principal
if not paid, is an unsubsidized loan, and is not based on
need. A Stafford subsidized loan is based on need, and no
interest accrues during school years nor needs to be repaid
during school. Six months after school ends, payments commence
for both the unsubsidized and subsidized programs.
loans are enhanced (“supersized”) when parents
do not qualify for a Parent (PLUS) loan. Students can borrow
the amounts as listed in Exhibit
J. Knight, CPA, practices in Fairfield, Conn.
Note: This is adapted from an article published
in the April 2004 issue of Financial Planning magazine
and is reprinted with permission.