Student Loan Rates Increase, Underscore Skyrocketing College Costs

With increasing interest rates, student loans are a heavy burden on many college graduates.

If the fed doubles the interest rate on student loans, but nobody takes out one of those loans, did the cost of college still go up?

The answer is yes. If that brain teaser seems complicated, that’s because it is. So let me simplify what the rate increase means and explain the options for managing the rising cost of tuition.

Congress agreed last year that the federal government’s interest rate for subsidized student loans would balloon from 3.4% to 6.8% if they weren’t able to set a new rate by July 1, 2013.[1] Despite a flurry of negotiations, Congress hasn’t been able to find a compromise. Today the 6.8% rate is a stark reminder that college costs only go in one direction. Unless a deal is reached, students and parents should expect to pay an extra $1,000 for loans and some experts say that number is closer to $2,600[2].

For now, this huge swing has left families in a difficult spot and more expensive loans underscore the challenge of paying for college in the first place. The Merrill Edge Report for Spring 2013 found that families who have their financial acts together—some assets and some money in the bank—plan to use a mix of sources to pay for their children’s education. That mix includes federal loans.

No matter what stage of life you are in—grandparent, parent, 20-something, or teenager—you need a plan in place to pay for college. Here are six ways to start:

  1. Together, set a clear goal. Estimate what percentage of your child’s college expenses you hope to pay for. In the past decade, the cost of a four-year school rose 5.6% per year, far outpacing inflation.[3]
  2. Look at other families’ strategies for context. You don’t have to be the sole funder of your child’s education. Most families use a combination of savings, gifts, grants, scholarships and loans.
  3. Start saving as early as you can. The sooner you begin, the greater your chances of reaching your goal.
  4. Talk with your kids. To avoid surprises, talk with your kids about college costs and expectations when they’re young.
  5. Explore financial aid. Since you have already agreed how much you will contribute to your child’s education, you can look for scholarships, work-study programs and grants as college approaches.
  6. Consider investing in a Section 529 plan. Contributing to a 529 plan could potentially have significant tax advantages. If appropriate, let relatives know they can open a 529 plan as an estate planning tool and designate a beneficiary.

Finally, the best thing you can do is talk to a qualified financial professional who can lay out what the recent rate increase means for your family in the short term, and help you make sense of college savings for the long term.

Wesley G. Gunter is a Financial Solutions Advisor with Merrill Edge which offers team-based advice and guidance brokerage services. He can be reached at (949) 616-1297 or via email wesley.gunter@ml.com. Merrill Edge is available through Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S), and consists of the Merrill Edge Advisory Center (investment guidance) and self-directed online investing. MLPF&S is a registered broker-dealer, member SIPC and a wholly owned subsidiary of Bank of America Corporation. Investment products are not insured by the FDIC; not deposits or other obligations of any bank and are not guaranteed by any bank; and are subject to investment risks, including possible loss of the principal invested.

Wesley Gunter was a guest oCollege Smart Radio “Tackling the Runaway Costs of College”  on July 27th, 2013.  Listen to this broadcast on YouTube here.

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