Private loans certainly have been gaining a foothold in the student loan market. In the 2005-2006 academic year, more than 6 million undergraduates borrowed nearly $37 billion through the Stafford loan program. Meanwhile, students took out roughly $17 billion in private student loans, which represents a threefold increase over four years. It may look like a drop in the bucket, but if current trends continue, market share for private lenders can only grow.
What trends? The continually rising costs of a college education coupled with limits on federal loans. A new study, The Future of Private Loans, cites the scary expectation that private loan volume will exceed that of subsidized Stafford loans by 2010.
Plenty of horror stories exist about private student loan interest rates climbing to levels approximating those of credit cards and principal balances ballooning to twice and thrice the original loan amounts. The problem: Private loans often feature variable rates, and the rates are sometimes based on credit history. Late or missed payments by a young person can result in a disastrous outcome.
In contrast, interest rates on federal loans are fixed and set by law. Federal loans also offer more flexible deferment and forbearance options. Private lenders make their own rules on such matters, and most are not that flexible.
Preparation is the best approach
Parents or students with well-funded 529 plans are in the best position, especially now that the tax exemption on these savings vehicles has been made permanent.And now there's another reason to like them: Student-owned 529 plans no longer need to be reported on the FAFSA. For the 2005-06 and prior years, they counted against the student at the high 35 percent rate in determining financial aid eligibility. (The student rate, by the way, changes to 20 percent effective this July.) But the Deficit Reduction Act, signed into law early in 2006, changes how 529 plans are assessed.
"A student filing the FAFSA as a dependent student should exclude self-owned 529s and Coverdell ESAs from the application," says Bankrate's College Money Guru, Joe Hurley. However, if the student is independent from a tax standpoint, then the value of the account should be reported as an investment.
Students have a strong incentive to transfer other investment assets, such as those in an UTMA or UGMA custodial account, into a 529 plan prior to filling out the FAFSA, Hurley says. Doing so "will improve the student's aid eligibility -- but watch out for income taxes on the liquidation."
If the 529 is a parent-owned account, there's no big reason to transfer it to a student-owned account, Hurley adds. That's because parental assets are only assessed at a maximum rate of 5.6 percent. "Placing those assets into a student-owned 529 means the parent has irrevocably given away those assets," Hurley warns.
So parents and students, look at the FAFSA as an easy, open-book, take-home test. Get it over with soon. You never know -- you just might be pleasantly rewarded for your efforts.