Should you refinance your student loan by using a lower-interest home equity loan?

Should I use a home equity loan to refinance my student loans at a lower interest rate?

Rohit Chopra, the Consumer Financial Protection Bureau’s Student Loan Ombudsman, looked at the option of using a home equity loan to refinance existing student loans.  This would only apply to homeowners with significant equity, probably someone out of college ten years or more.  The main advantage would seem to be the ability to swap a high-interest student loan for one with today’s enticing low rates.  The window of opportunity for using this strategy may be closing soon, with expectations by some forecasters that an increase of interest rates is on the horizon.

Here are some important considerations.

• Your rate may be lower, but your home is at risk. Interest rates for home equity loans are generally lower than interest rates for student loans. (Lenders are willing to offer a lower interest rate because they know that if you don’t pay, they have a legal claim on your home.) If you can’t pay, you could end up in foreclosure.
• On your federal loans, you are giving up repayment options and forgiveness benefits. Federal student loans feature a number of protections for borrowers that run into trouble, including Income-Based Repayment (IBR). These benefits no longer exist when you pay off a federal student loan with a home equity loan.
• This may impact your taxes. The interest you pay on a home equity loan could equate to a greater tax benefit for some borrowers, when compared to the student loan interest tax deduction, especially if you have high income and itemize deductions. You may wish to consult with a tax advisor when considering your options.

Last year I wrote about this topic from a parent’s perspective, addressing  the question of whether a federal Direct PLUS parent loan or a home equity loan is better for financing a child’s college costs.

Preferential packaging – college financial aid as a recruiting tool

Preferential packaging of financial aid is commonly used by private colleges and universities.  Because schools are not transparent about this strategy, many families are ignorant of how it works.  Muhlenberg College is unusually open about explaining this practice.

Preferential packaging means, simply, that the students a college would most like to enroll will receive the most advantageous financial aid packages.

There are three basic types of financial aid (FA):  grants, loans, and work.

A preferential financial aid package includes a far greater percentage of grant aid than self-help (loans and work). Because they have discretion over how much grant aid they choose to award a student, a college can award a bigger grant to a student they would really like to enroll….

Willamette University also is exceptionally forthright about its preferential packaging.

For students with demonstrated financial need, the percentage of need that is met with “gift-aid” (scholarships and grants from all sources) will also reflect the students’ academic standing within our admitted applicant pool. In other words, the stronger the student, the greater the scholarship award is likely to be.

Let’s look at an example from a CollegeConfidential post.

In this case the college’s Cost of Attendance (COA) is $40,000, and two applicants have the same financial need but quite different academic credentials.

Student A ACT 33 GPA 4.0 EFC = $7k

Student B ACT 24 GPA 3.2 EFC = $7k

Student A is more attractive to the college because his stats would improve the school’s stats.  Perhaps Student A is also an Underrepresented Minority (URM), another desirable factor.  Both students will be offered $10,000 in FA, but Student A will receive a preferential package that does not include a loan.

Financial Aid Offered
Student A:  $8,000 grant; $2,000 work-study – Total = $10,000
Student B:  $3,000 grant; $5,000 loan; $2,000 work-study - Total = $10,000

Note that these awards are technically “need-based”, but in fact do take merit into consideration.  If it is the official policy of this college only to offer FA based on need and not on merit, another student with the highest of academic credentials but lacking any financial need (EFC = COA) would receive nothing.

What it means to applicants

• Students seeking to maximize financial aid should apply to schools where their statistics place them in the upper third of the applicant pool.
• Students with no financial need are shut out of many merit awards that include a need component.

Related:

• Psst – one of Duke’s so-called merit scholarships is actually need-based (Cost of College)
• Family income matters for ‘merit’ awards at the University of Rochester (Cost of College)

Not enough borrowers take advantage of Income Based Repayment’s ‘mind-boggling’ generous benefits

The Obama administration and other supporters believe that not enough borrowers are taking advantage of Income Based Repayment (IBR), a student loan forgiveness program.  However, since it is higher-income college graduates who “ultimately end up benefiting overwhelmingly from IBR”, I’m not sure this is a problem.

IBR reduces loan payments based on a percentage of income, subsidizes interest charges, and forgives loan balances after 25, 20, or 10 years.  It sounds like a nice deal.  However, knowledge of the IBR ”remains a largely obscure concept for many cash-strapped college graduates”.  It is estimated that only about one-half of qualified borrowers are taking advantage of this free money.

… according to DOE data as recent as January, a little more than 2.3 million borrowers had applied for IBR nationally, a small fraction of the estimated 38 million Americans with outstanding student loan debt…

Such low figures have shone a glaring spotlight on the DOE’s failure to sufficiently educate borrowers, according to consumer advocates like Mark Kantrowitz, the publisher of FinAid.org and FastWeb.com, who estimates that as many as 3 million students could qualify.

Hypothetical examples generated by using the New America Income-Based Repayment Calculator show how forgiven loan amounts can reach into the six figures.  (All numbers are approximate.)

Loan amount:  $70,000 combined undergraduate and graduate
Income:  $40,000 initially with 2.5% annual increase

Without IBR:  $550-600 monthly loan payments with total repayment cost of $165,000 including principal and interest

With Old IBR:  $300 monthly loan payments with total repayment cost of $98,000 including principal and interest  –  Savings = $65,000

With New IBR:  $160-170 monthly loan payments with total repayment cost of $49,000 including principal and interest  –  Savings = $115,000

Old IBR applies to initial loans dated on or before October 1, 2007, while the more generous New IBR applies to loans after that date.

The millions of borrowers who qualify but do not participate are “effectively leaving a rather sizable amount of money on the table”.  Some of the most generous IBR benefits go to graduates who take jobs in non-profit or government sectors because their loans are forgiven after only ten years.  Jason Delisle, director of the Federal Education Budget Project at the New America Foundation, advises college graduates to take advantage of this benefit.

“If you plan on doing any kind of public service, nonprofit or government work,” said Delisle, “then you should borrow as much money as [your school] will possibly let you.”

Under the New IBR, a student who owes $70,000 upon graduation would end up paying back only $22,000 if he stayed ten years at a government job with a starting salary of $40,000.  That’s a savings of $143,000 compared to how much that graduate would have paid had he not taken the IBR option.

Indeed, the IBR savings that accrue to borrowers who pursue such career paths can be mind-boggling.

IBR produces “far more benefits” to higher-earning graduates.

But it’s not only those who work in public service professions who benefit disproportionately from IBR, according to Delisle. “The program provides far more benefits to those at the higher end of the income spectrum,” he noted, such as doctors, lawyers and those with MBAs.

“While the program provides very large subsidies when your income is low,” he said, “it really doesn’t claw those benefits back if your income ends up being high,” meaning graduates with large sums in student loan debt—ordinarily graduates of medical, law and business schools, who typically make higher starting salaries—ultimately end up benefiting overwhelmingly from IBR.

So a student who graduates from Harvard Law School with $150,000 in student loans and goes to work at a law firm making close to six-figures annually still stands to receive a “windfall”—as Delisle calls it—of six-figures in principal and interest forgiven on average.

IBR cheerleader says everyone should borrow for college because the taxpayers “pick up any downside risk or loss”.

Because of IBR there’s “no reason not to pursue a graduate degree and borrow to pay for it,” said Delisle.

“There’s only upside, because the government is stepping in to pick up any downside risk or loss,” he said. “It’s mind-blowing how generous income-based repayment really is.”

Sounds like a lousy program to me, speaking as a taxpayer.

Related:  Income Based Repayment (IBR) is a ‘moral hazard’ for high-income student loan borrowers (Cost of College)

Parent PLUS loans are similar to no-doc mortgage loans

Parent PLUS loans, which are ”both remarkably easy to get and nearly impossible to get out from under“, can be a trap for uninformed borrowers.

Remember no-doc mortgage loans?  Parent PLUS loans, federally sponsored and available for parents of college students, are eerily similar.

The loans are both remarkably easy to get and nearly impossible to get out from under for families who’ve overreached. When a parent applies for a PLUS loan, the government checks credit history, but it doesn’t assess whether the borrower has the ability to repay the loan. It doesn’t check income. It doesn’t check employment status. It doesn’t check how much other debt—like a mortgage or other student loans—the borrower is already on the hook for.

Designed for families who may not qualify for other types of debt, PLUS loans “sometimes hurt the very families they are intended to help”.

Of course, Parent PLUS can be an important financial lifeline—especially for those who can’t qualify for loans in the private market. An iffy credit score, high debt-to-income ratio, or lack of a credit history won’t necessarily disqualify anyone for a PLUS loan. Applicants are approved so long as they don’t have an “adverse credit history,” such as a recent foreclosure, defaulted loan, or bankruptcy discharge.

No cap on loan amount

Unlike other federal student loans, PLUS loans don’t have a cap on borrowing. Parents can take out as much as they need to cover the gap between other financial aid and the full cost of attendance. Colleges, eager to raise enrollment and help families find financing, often steer parents toward the loans, recommending that they take out thousands of dollars with no consideration as to whether they can afford it.

Harsh treatment for debtors who run into trouble

When it comes to paying the money back, the government takes a hard line. PLUS loans, like all student loans, are all-but-impossible to discharge in bankruptcy. If a borrower is in default, the government can seize tax refunds and garnish wages or Social Security. What is more, repayment options are actually more limited for Parent PLUS borrowers compared with other federal loans. Struggling borrowers can put their loans in deferment or forbearance, but except under certain conditions Parent PLUS loans aren’t eligible for either of the two main income-based repayment programs to help borrowers with federal loans get more-affordable monthly payments.

Parent PLUS spending has shot up over the last decade.

Last year the government disbursed $10.6-billion in Parent PLUS loans to just under a million families. Even adjusted for inflation, that’s $6.3-billion more than it disbursed back in 2000, and to nearly twice as many borrowers.

An interactive list of schools with accompanying Parent PLUS data shows that many of the institutions with the highest average loans are art and music colleges.  New York University is ranked 11th, with an average loan balance of $27,305.

Related:

• Qualifying for a parent Direct PLUS loan (Cost of College)
• Federal Direct PLUS or home equity loan for college costs? (Cost of College)

Does the government make a profit on student loans? It’s complicated

The question of whether the federal government profits from student loans has come up recently in discussions about the various proposals to prevent the scheduled Stafford subsidized loan rates from doubling to 6.8% on July 1.  This question puzzled me when I wrote about it last November.  At that time I found conflicting accounts, which frankly made my brain hurt.  Since I was left with a lingering curiosity about these illusive profits, the recent discussions on the topic caught my attention.

On May 16  the Huffington Post reported of projected federal profits exceeding those of Exxon, Apple, and other corporate giants.

Figures made public Tuesday by the Congressional Budget Office show that the nonpartisan agency increased its 2013 fiscal year profit forecast for the Department of Education by 43 percent to $50.6 billion from its February estimate of $35.5 billion.…

The Education Department has generated nearly $120 billion in profit off student borrowers over the last five fiscal years, budget documents show, thanks to record relative interest rates on loans as well as the agency’s aggressive efforts to collect defaulted debt.

But that rate is set to double to 6.8 percent, the rate for unsubsidized loans (for richer students, or poor students with debt above the subsidized loan program’s limits), on July 1.

The Washington Post, in reporting on the political disagreements in Congress, referenced the DOE’s $51 billion projected profit.

Democrats … objected to increasing the rates within a program that generates vast income for the federal government. The Congressional Budget Office this week revised its figures this week, reporting that federal loans will generate almost $51 billion this year. Over the last five years, that sum is almost $120 billion.

“That $51 billion is more than Exxon,” Miller said.

“It’s time we stop using federal student loans as a profit center,” added Rep. John Tierney, D-Mass.

Writing for Yahoo Finance, Jason Delisle disputes this notion of student loan profits, pointing out that the high risk of default must be considered.

What about Senator Warren’s claim that the government makes money off loans to low-income students? Senator Warren is not telling the whole story here either. She points to figures that the non-partisan Congressional Budget Office says “do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpayers.” In fact, when the budget office “accounts more fully… for the cost of the risk the government takes on when issuing loans,” it reports that Subsidized Stafford loans – those made to low-income students – cost taxpayers $12 for every $100 lent out, or $3.5 billion per year….

The claim that the government makes money on these loans is even more dubious given that the Department of Education estimates that 23 percent of the Subsidized Stafford loans it makes this year will default. That puts it among the riskiest loan programs that the federal government runs. By comparison, about 7 percent of the loans under the Federal Housing Administration mortgage program are expected to default. That program provides loans to high-risk borrowers who do not qualify for a traditional mortgage because they lack the savings, income or credit history.

Finally, in the May 20 Washington Post WonkBlog Dylan Matthews concludes that the “federal government does not profit off student loans”, at least not “in some years”.

Matthews reiterates that the interest rates do not reflect market risk.

… they set the interest rate on student loans below the market rate. And because they’re below the market rate, that costs the federal government money. Contrary to popular belief, and many a breathless article, the government does not, in fact, book a profit on student loans. As New America’s Jason Delisle has explained, that’s because the Congressional Budget Office is required by law to use a bizarre and faulty method for determining the cost of government loans.

Matthews goes on to explain what is essentially an unresolved dispute on the profitability of government student loans.  Additional details complicate the picture.  For example, even according to the CBO’s “bizarre and faulty” calculations, some years with higher subsidies actually show a loss.

I suspect there’s no profit.

After reading all these explanations, the most definitive statement I will accept is that it appears the government does not make a profit on student loans, but it might depend on the level of subsidies for any given year.  As the headline says, it’s complicated.

Getting answers to essential questions about a college’s financial aid policies

College financial aid policies can vary significantly, so be sure to check with each school.

The CollegeBoard suggests an interested student or parent “schedule a phone meeting or an interview with a member of the financial aid staff“ to get answers to any questions that are not answered by information on the college website.

A list of 12 questions to get you started on gathering information is provided.  In my experience, the answers to most of these questions can usually be found on college websites, so be sure to check there before you make a call.

A dozen questions to get you started:

1. What’s the average total cost — including tuition and fees, books and supplies, room and board, travel, and other personal expenses — for the first year
2. How much have your costs increased over the last three years?
3. Does financial need have an effect on admission decisions?
4. What is the priority deadline to apply for financial aid and when am I notified about financial aid award decisions?
5. How is financial aid affected if I apply under an early decision or early action program?
6. Does the college offer need-based and merit-based financial aid?
7. Are there scholarships available that aren’t based on financial need and do I need to complete a separate application for them?
8. If the financial aid package the college offers isn’t enough, are there any conditions under which it can be reconsidered, such as changes in my family’s financial situation or my enrollment status (or that of a family member)?
9. How does the aid package change from year to year?
10. What are the terms of the programs included in the aid package?
11. What are the academic requirements or other conditions for the renewal of financial aid, including scholarships?
12. When can I expect to receive bills from the college and is there an option to spread the yearly payment over equal monthly installments?

If you want to be super organized, you can create a spreadsheet with all relevant data.

Amid declining household debt, rising student loans remain a drag on the economy

Total household debt continues to decline, but rise in student debt hampers economic recovery.

The total amount of debt held by Americans fell again in the first three months of the year and stood at the lowest level since the middle of 2006, the New York Federal Reserve said Tuesday….

The level of household debt in the first quarter fell by $110 billion, or 1%, to $11.23 trillion, mainly because consumers reduced mortgage balances and used their credit cards less.

A…
Auto and student loans rise.

The increase in the value of auto loans was the smallest in four quarters, suggesting that car companies might have cut prices to attract buyers as demand for new vehicles slackened. Still, auto loans rose $11 billion to $794 billion to mark the ninth straight quarterly gain.

Student loans have ‘surged 46% since the end of the recession’.

Student loans, which climbed $20 billion in the first quarter, have surged 46% since the end of the recession to an all-time high of $986 billion. More students are going to college or remaining in school longer to obtain graduate degrees to improve their chances of finding a job amid a slow economic recovery.

Yet the escalation in student loans is also leaving many young people saddled with large debts. Although the delinquency rate on student loans fell slightly in the first quarter to 11.19%, that’s still the second highest rate ever. Before the recession, delinquencies averaged around 7%.

The decline in household debt is good for a recovering economy, but economists believe growing student loans are ‘acting as a drag on growth’.

The anemic economy has left millions of younger working Americans struggling to get ahead. The added millstone of student loan debt, which recently exceeded $1 trillion in total, is making it even harder for many of them, delaying purchases of things like homes, cars and other big-ticket items and acting as a drag on growth, economists said.

Quick Links – College grade inflation; understating federal cost of student loans; trends in physical education

College grade inflation

Forty years ago, only 10 percent of grades awarded by Yale College were in the A-range. Last spring, that percentage was 62.

Yale is reviewing its grading policy.

“If B-plus is being kept for bad work, and virtually everyone is getting A or A-minus, this eliminates any genuine feedback,” Kagan said. “I’ve always thought this is a disservice to undergraduates.”

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The federal government systematically undercounts the cost of student loans by ignoring market risk.

… the federal government’s accounting practices systematically understate the cost of student loans by failing to account for market risk. A superior method called “fair value accounting,” which is the strong preference of academic economists and the Congressional Budget Office (CBO), would show considerably greater costs due to the risk associated with expecting loan repayments….

However, almost all economists believe that the way the federal government accounts for student loan costs is simply wrong. Under the principles of “fair value” accounting, which the CBO endorses, the discount rate applied to the revenue from students’ repayments should be much higher than the rate on U.S. Treasuries. A higher discount rate would reduce the present value of those repayments, thus increasing the cost of the student loan program to the government.

The reason the discount rate is higher is because it incorporates the price of market risk into cost estimates, while current accounting practices ignore that risk. Students might pay back what the government predicts they will, but taxpayers must cover the full cost of the loan regardless. Since defaults tend to occur when the economy is weak, taxpayers face the risk of losing expected funds at a time when budgets are least flexible.

Thus, the government’s budgetary estimate reflects only part of the fair value cost of offering a student loan. Additional cost comes from the risk that loan repayments will be lower than expected.[6] The federal government should use a higher discount rate to reflect the risk that expected loan repayments will not materialize.[7]

This reminds me of how state governments consistently underfund pension obligations, inflating discount rates to hide true taxpayer liability.

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High school PE classes focus more on activities that will continue through to adulthood, including work-outs at fitness centers.

High schools are installing gyms for PE.

Forget dodge ball, squat thrusts and being picked last for the team. Today’s high-schoolers are more likely to get a workout in what’s becoming a must-have tool in physical education: a state-of-the-art fitness center.

Less focus on team sports and more emphasis on developing fitness habits that will last a lifetime

“There’s a lot of people who aren’t on the Scarsdale High School football team, and yet they want to be healthy,” he said. “I would anticipate using the treadmill and the machines for gaining muscles.”

There’s a new crop of physical education teachers coming out of college who are preparing to reach students, such as Gale, who don’t just want to learn to play a sport, said Robert Schmidlein, a professor of physical education at Manhattanville College.

“It’s a paradigm shift,” Schmidlein said. “People don’t play team sports when they get older. Less than 1 percent of the adult population plays team sports. Seventy percent of kids drop out of youth sports by age 13. No one should be teaching team sports at the high school.”

“Fit for Life”
Our local high school offers PE students a choice between two options for each class unit, with one usually involving a team sport and the other involving a fitness activity like yoga or running.  While we don’t have a Scarsdale-level fitness center, we do have a small selection of treadmills and elliptical machines.

Career and money advice for new college graduates

If you’re a millennial, do these things, or else risk remaining unemployed for a long time.

1. Wake up early. Job seeking is a full-time job.
2. Don’t pass on everything. No entry-level job is ideal.
3. Stop relying on mom and dad.

Career advice from Aol Jobs, summarized by FINS Morning Coffee

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With two out of three college graduates averaging more than $24,000 in student loans, Fox Business steps in with this financial advice.

Step 1: Create a Budget

Even if grads don’t have a concrete post-grad plan just yet, creating a budget of projected expenses such as bills, rent and discretionary spending can help them better understand their cash flow situation, suggests John Bucsek, managing director with MetLife Solutions Group. …

Making a budget doesn’t have to be an overwhelming prospect—grads can easily keep up with their expenses using sites like Mint.com or creating a simple spreadsheet….

Step 2: Figure Out Student Loan Terms

Grads typically only have a six-month grace period before having to start repaying student loans, making it essential to secure a job and stay on top of other expenses.

Unemployed or financially-strapped grads should consult with their lender to determine repayment options available to them such as deferment, forbearance, and Income Based Repayment plans should they have issues making payments on time….

Step 3: Get High Interest Debt in Check

Whether grads are an authorized or co-signed user on a parent’s card or have their own account, they should  focus on getting the debt with the highest interest rate paid down first.

Understanding how debt impacts future goals and how credit score plays into every major purchase can help them stay on top of making steady payments and monitoring credit history health, says Bucsek.

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A variation on the expert’s advice

Since the percentage of young adults living with their parents has risen to 22% today, from 11% in 1980, it appears the recommendation to “stop relying on mom and dad” is being ignored by many.  Here’s my variation on the preceding advice.

1. Get up early every day to find a job, or to hone your skills to make yourself more employable.
2. Even if you can’t find a job in your field, work somewhere, even if it’s part-time.  Earn some money.
3. If you’re living at home, use the opportunity to save aggressively and/or pay down student loans.

 Related:  Parents have lower expectations for kids becoming financially independent (Cost of College)

Do we have a student loan crisis?

While it’s unlikely that student loans on their own have created a crisis, they do seem to be a drag on our struggling economy.

When the The Atlantic looked at the student loan “crisis”, some of the numbers are alarming.

… The cost of college has spiked 150 percent since 1995, compared with a 50 percent increase in the cost of other goods and services. Last year, outstanding student loans soared to nearly $1 trillion—a 300 percent jump since 2003. College is an undeniably risky investment, seemingly more so than ever. But are rising debt levels a national crisis?

But their infographic presented a more balanced look at some of the numbers, with the first three sections making the argument that the averages do not support the idea of a crisis.

…
Not a crisis, but problematic for a struggling economy

Updated 2012 numbers from the Federal Reserve Bank of New York report

The paper starts by noting that student debt has grown dramatically over the last decade — some 43 percent of Americans under the age of 25 had student debt in 2012, with the average debt burden now $20,326. By contrast, back in 2003, just 25 percent of younger Americans had debt, and the average burden was $10,649.

Younger Americans with student debt are less likely to buy homes and automobiles, holding back spending that has typically fueled past economic growth.

… it looks like rising student debt really might be eating into the housing and auto markets. If so, that could have big implications for the U.S. economy. Auto and housing sales have been a huge driver of growth these past few years, though auto sales are still well below their peak. (Analysts are expecting around 15 to 15.5 million sales in 2013, versus an average of 16.6 million per year during the 2000s.) If younger Americans are retreating from those markets, that could help slow down the recovery.

Related:  College debt levels higher than all other types of consumer loans (Cost of College)