If your college fund is low, a Stafford loan is a good bet

What do you do if the 2008 stock market plunge ravaged your child’s college account and you don’t have time to build it back up? It may be time to figure out a borrowing plan.

Parents of many college-bound seniors are in the throes of contingency planning because the market’s swoon left them with far less than they expected.

Those who have enough for this year but not subsequent years might be tempted to cash out what’s left of the college money and worry about the rest later.


But that could be a costly mistake, said Lynn O’Shaughnessy, author of a book and a blog called “The College Solution.”

That’s because it’s cheap to borrow a portion of tuition using government programs, but if the amounts get too high you might have to turn to private lenders, whose interest payments can get really expensive.

If you need to borrow, it might be smarter to borrow a little every year, conserving enough savings and cash flow to ensure that you are never forced to borrow at high rates.

To understand how to set up a borrowing plan, you need to know that there are four different types of student loans that are readily available to almost everyone.

Subsidized Stafford loans are low-cost, government-guaranteed loans available to students with need.

Unsubsidized Stafford loans are government-guaranteed loans available to all students.

PLUS loans are government-guaranteed loans made to parents.

Private or signature loans are not guaranteed by the government and can be issued at rates as high as 20%.

There are additional loans -- some provided by schools to students with need -- but if you qualify for these, the school will have included them in your financial aid award letter.

The two best options are the federally guaranteed student loans named after the late Sen. Robert Stafford (R-Vermont); however, there are annual caps on how much a person can borrow from the Stafford program.

Subsidized Stafford loans are given to students who demonstrate some “need” according to financial aid formulas. The interest rate on this loan varies, but for the 2009-10 school year, subsidized Staffords are issued at a 5.6% fixed rate. Next year the rate will be even lower -- 4.5% -- thanks to financial aid legislation passed last year. In 2011, it will drop to 3.4%.

What makes subsidized Stafford loans even more attractive is that the government pays the interest while the student is in school. So if your freshman takes out a $3,500 subsidized Stafford loan, she will owe $3,500 in 2013 when she graduates.

With other types of student loans, the student doesn’t need to pay interest while in school, but the interest accrues. At the same interest rate, $3,500 borrowed for freshman year would grow to more than $4,300 by graduation.

The amount a student can get in subsidized Stafford loans varies based on how close she is to graduation. The maximum is $3,500 for freshmen; $4,500 for sophomores; and $5,500 a year for juniors and seniors.

Apply at the Free Application for Federal Student Aid website, at (Don’t be confused by the similarly named, which charges for the application. The Free Application for Federal Student Aid is free.)

Don’t qualify for subsidized loans? Need more money? The next-best bet is the unsubsidized Stafford loan, which is issued at a 6.8% fixed rate.

Freshmen can borrow up to $5,500; sophomores are capped at $6,500; and juniors and seniors at $7,500. Those maximum amounts include any loans that the student has taken from the subsidized version of the program.

The downside of unsubsidized Stafford loans: Interest accrues while the student is in school, so a student who borrows $5,000 to pay freshman tuition would owe $5,340 at the start of sophomore year, $5,703 at the start of junior year, $6,091 at the start of senior year and roughly $6,500 soon after graduation. That’s simply the effect of the accrued interest.

If Stafford loans are not sufficient to handle the college funding shortfall, parents might want to consider PLUS loans, which are issued at an 8.25% fixed rate.

A last-ditch option is private loans, which are generally issued at variable rates that hinge on the student’s and parent’s credit ratings. In many cases, fees for private loans range from 2% to 10%, and rates can be as high as 20%.

Parents can borrow up to the entire cost of college with PLUS and private loans, but it’s expensive debt and the interest accrues while your children are in school. By the time they graduate, they (and you) can end up owing twice as much as what was borrowed.

O’Shaughnessy says she’d consider a home equity line of credit before a private loan, and maybe even before a PLUS loan, because it’s currently far cheaper than either of the other options. The down side: Home equity lines are typically variable-rate loans. If interest rates rise, the cost of your loan will too -- and your house is on the line if you have trouble paying back the debt.