Student loan rate hikes give more reason to save

http://www.savingforcollege.com/articles/student-loan-rate-hikes-give-more-reason-to-save

Those planning on taking out loans to pay for college may want to rethink their strategy. Beginning July 1, we will see a 0.8% increase in interest rates on all federal student loans. For the 2013-2014 school year, Federal Direct Stafford Loans for undergraduate students will rise from 3.86% to 4.66%, and 5.41% to 6.21% for graduate students. Rates on Federal Grad PLUS and Federal Parent PLUS Loans, which were previously at 6.41%, will now be 7.21%.

What does that mean for you? The average current cost of a 4-year public university is around $25,000. College freshman this year who took out a Direct Stafford Loan for this amount at a 3.86% interest rate and a 10-year repayment period will end up paying $30,174.41 over the life of the loan. Next year’s incoming class would end up paying $31,323.37 for the same loan amount at the new 4.66% interest rate. That’s paying $1,148.96 more in interest! See for yourself with the Federal Student Aid Repayment Estimator.

Most of us have gotten comfortable in this low-interest rate environment, but experts warn that the end may be near. According to a recent article from USA Today, we should expect the upward trend in overall interest rates to continue. According to a May report from Diane Swonk, chief economist for Mesirow Financial in Chicago, in about a year we could see the first increase in the Federal Reserve’s (the Fed) short-term interest rates. That means in addition to student loan debt, consumers should be aware that credit card interest rates can also go up. Of course, the future is never certain but it can’t hurt to play it safe. With the possibility of debt becoming more expensive, it would be wise to pay down credit cards and limit the amount of loans you take out.

While rising interest rates may be the last thing a borrower wants to see, this could be great news for savers. Students who take out loans to pay for school will pay interest on the amount they borrow, but those who save money to pay for school will earn interest. So if interest rates rise, savers earn more.

As National 529 College Savings Day approaches, there is no better time to consider a 529 college savings plan if tuition bills are in your future. A 529 savings plan is an investment account that operates similar to an individual retirement account (IRA). Money is invested in a portfolio made up of mutual funds or other similar investments. Earnings generated from the account can be excluded from your federal income tax return, and withdrawals made toward qualified educational expenses are also tax-free. Most 529 plans are operated by one of the 50 states and will offer additional tax incentives for residents. However, you are not limited to investing in your own state’s plan if you find a better deal elsewhere. To celebrate 529 day this Thursday, many states are also running special promotions to encourage enrollment.

We can’t stress enough to parents that putting even a small amount each month into a 529 plan will cut down on the amount your child will need to borrow. Let’s say you have a seven year-old daughter and you think she will attend a 4-year public university. Using today’s current cost of $25,000, a college inflation rate of 5%, and an annual investment return of 6% you could start making monthly contributions of $764 to a 529 account and end up paying $128,300 to cover the total cost. On the other hand, if you choose to go the student loan route, your total repayments will be $230,909 using the new interest rate of 4.66%. That’s $102,610 more, and the difference would be even greater if interest rates continue to rise (which they are expected to). If you’ve been a borrower, it’s time to think about coming over to the other side.

Find out how much student loans could cost you!