College is expensive, and the best way to avoid huge amounts of debt is to make the most of financial aid while ensuring that you save toward educational expenses.
In this clip from Industry Focus: Financials, Motley Fool analyst Gaby Lapera and Director of Investment Planning Dan Caplinger look at the basics of the financial aid process, including the need to file an annual FAFSA and the pros and cons of various types of student loans that are available. As Dan and Gaby discuss in more detail, being smart about financial aid and the ramifications of various savings methods on the package you'll receive can help you maximize financial support and lower the amount of debt students carry out of college after they graduate.
A full transcript follows the video.
This podcast was recorded on Aug. 29, 2016.
Gaby Lapera: The third plan we're going to talk about is the Coverdell account. This is probably the least popular of them all, but people still use them, so I thought we would mention it. The reason that it's not very popular is that the total contribution limit for the Coverdell plan is $2,000, and that's total. You can have more than one Coverdell account for a kid, but it doesn't matter, because you can't contribute more than $2,000 to that child, to that beneficiary, over the course of a year. So, say grandma has a Coverdell account and the parents have a Coverdell account. They have to figure it out so that they don't exceed that amount.
Dan Caplinger: It's a per-year thing, and it's something that, once upon a time, $2,000 was equal to what the maximums allowed for IRA contributions, other sorts of contribution. For whatever reason, Congress didn't raise that limit to keep up with inflation the same way that IRA contributions do. So, while now you can contribute $5,500, $6,500 for IRAs, that $2,000 limit is still there. And most people find, again, the 529 plan with the much higher contribution limits lets you make a real dent in how much the total cost of college is going to be. We're up to several hundred thousand dollars over the course of a four-year program. $2,000 a year is nice, but it's not enough to get the job done for most people.
Lapera: Yeah, and it's not just that. There's also income limitations. In theory, if you're an individual that makes more than $110,000 a year, or a couple that makes more than $220,000 a year, you can't contribute to these at all. People have circumvented that by letting the kids open it up in their own name, and then contributing to it. But it's just kind of a headache that a lot of people don't really need. But what's interesting to me is that certain elementary and secondary schools also qualify for Coverdell accounts. So, you can use the money in them to pay for a private school, if you want to.
Caplinger: Right, private school, high school tuition, or something like that. But the lack of popularity, you can see how unpopular these are by the fact that even some major financial institutions don't even offer them anymore. It can be hard to find a place that will let you open a new Coverdell account. Really, in general, you're stuck with either the 529 or opening up a custodial account.
Lapera: So, let's say that you saved and they're still not quite enough, and your kid is about to go to college. There are a few things you should do. The first thing is to fill out the FAFSA, which stands for the Free Application for Federal Student Aid. This is something that you need to fill out every year. I knew a kid in college who thought that you only filled it out one time, and sophomore year, there was a rude awakening. You want to fill that out as soon as possible after January 1st. If possible, you want to file your taxes first.
Caplinger: Yeah. A lot of the information you're going to use on that financial aid form looks a lot like a tax return, in many ways. It's asking you for income information, for asset information, and yeah, the sooner you get it completed, the sooner you can check the box off as far as that aspect of running through your college or university's financial aid program, so they can calculate how much money they're going to be willing to give you in your financial aid package.
Lapera: Yeah. And the other thing to keep in mind is, you need to fill out the FAFSA, I believe, if you're going to take out federal loans.
Caplinger: That's true. It's something that almost all financial aid programs ... I can't think of a situation where there's a college or university that doesn't use that form. Sometimes, they'll ask for supplemental information that specific to whatever that college or university wants. But it's pretty much uniform at this point where everybody expects that FAFSA. That's one of the reasons that the gateway to opening up some of the federal funding for funding sources for education hinges on the student and the student's family having filled out that information correctly.
Lapera: Yeah. The reason that we're harping on this so much is that federal loans, in general, are a much better idea than private student loans. That's because interest rates on federal loans tend to be much lower.
Caplinger: That's right. There's also the benefit, some federal loans have deferment provisions where they'll actually give you an interest-free period while you're in school, even sometimes for a limited period of time after you come out of school. Most private loans don't have that sort of thing. They might not make you make payments, but the interest is accumulating in the background, so when you do start making those payments, it's on a higher amount, because that interest has been accumulating. So, yeah, the federal programs, in general, lower rates, better repayment terms, some qualifications for better treatment, and also some eligibility for various types of loan forgiveness programs, depending on what career path you decide to follow after you come out of school, then loan forgiveness can be an option as well.
Lapera: Yeah, and let's chat about that really quick -- the three main programs that the federal government offers for loan forgiveness -- and this only applies to federal loans. So, if you have private loans on top of your federal loans, you still have to pay those off.
There's the Public Service Loan Forgiveness Program. Loans are forgiven after making 120 qualifying monthly payments. That's 10 years worth of payments, while working full-time for a qualifying employer. Those tend to be non-profits, the government, they have a whole list of places that you can work where you would qualify for this.
There's Teacher Loan Forgiveness. You need to make five consecutive years of payments. You need to work for at least five years in low-income public schools, which is an option you can do. They offer up to $17,500 in direct loans or Stafford Loan Forgiveness. While you qualify for the Teacher Loan Forgiveness, you also qualify at the same time for Public Service Loan Forgiveness if you work for another five years.
And there's also the Perkins Loan Cancellation if you have a Perkins loan. Perkins loans are given to students who have extraordinary financial need. You can have up to 100% of your loan forgiven if you work in public service for up to five years. If you're wondering about what kind of jobs qualify for this, you just need to go online, the government has plenty of resources available for you to figure this out.
Caplinger: There's also been a lot of talk during the recent presidential election campaign about just how overwhelming student loan debt is in general. There's going to be a big political push, especially as the current generation of students who are coming through school, who are five or ten years out of school. As they start to get politically mobilized, I think you can expect to see a lot of pressure to try to expand some of these forgiveness programs.
The impact that the large amounts of debt that people are coming out of school with is having an impact on the economy. People are delaying buying homes longer than they did, they're living with their parents more. We're even saying some studies that say people are delaying having families longer because they're buried under this debt, and they don't want to start a family until they have more financial stability in their lives, to be able to cover the expenses of having a child, and hopefully put their student loan stuff behind them at that point.
Lapera: Right, and correct me if I'm wrong -- if you file for bankruptcy, that doesn't apply to your student loans, right?
Caplinger: It's a much higher barrier to have student loan debt discharged in bankruptcy. It's not 100% never, but it's a lot harder to convince a bankruptcy court that you can get them extinguished. So, for the most part, yes, even if you're successful and having credit card debt, car loan debt, that kind of thing extinguished in a bankruptcy preceding, the student loan lender is still going to be able to come back and say, "Yes, you filed for bankruptcy, but because of this federal provision, we're still going to be able to collect going forward on that."