The cost of borrowing for college is rising along with the price of college itself. Here's what you need to know.
By Karen Wallace | 06-07-17 | 05:00 AM | Email Article

College affordability (or the lack thereof) is a growing problem. According to data from the College Board, the average cost of a year of tuition for an in-state student at a public university was over $9,600, and private college was over $33,000 for the 2016-17 school year--an increase of 2.4% and 3.6%, respectively, over last year's cost. (And that's just tuition and fees; room and board will add roughly $10,000 to those totals, according to College Board estimates.)

Karen Wallace is a senior editor with Morningstar.com. Follow her on Twitter @KarenW60602.

Many believe that college shouldn't be as expensive as it is, and the price tag shouldn't be growing at such a steep rate. A report published in March by the Institute for Higher Education Policy explores the issue of college affordability in the United States and concluded that high college costs are "stymieing progress for Americans of limited financial means, undermining our basic ideals of opportunity and fairness." The study attempted to illustrate how few colleges meet a reasonable threshold of affordability for students of modest means. The report suggested actions that federal, state, and institutional policymakers could take to help level the playing field.

The Rising Cost of Student Loans
The unfortunate truth is that most students can't afford to pay full freight for college, so they need to borrow to pay for it. According to data from the Federal Reserve Bank of New York, borrowers owe around $1.3 trillion in student loan debt.

To make matters worse, the cost of borrowing money to pay for college is rising along with the cost of attending college. Beginning in July, the interest rates on federal student loans will increase modestly. Though this is the first time the loans have increased since 2014, it doesn't come as a huge surprise as the Federal Reserve has moved the fed funds rate higher over the past few years. (The Department of Education's formula for setting the interest rates on federal student loans uses the 10-year Treasury note rate in its calculation.) 

But even though the rates on student loans are rising, they may still be a better choice than private student loans, even those that advertise lower rates. For instance, if that low advertised rate is a variable rate, that means there is a possibility that the base rate (and therefore the monthly payment) will increase over the life of your loan, sometimes by a large percentage. Also, the lowest advertised rates may not be available to borrowers with low credit scores or a lack of credit history.

In contrast, federal student loans' fixed rates are good for the life of the loan, and rates are not based on a borrower's credit. 

Federal loans, both subsidized and unsubsidized, have yearly limits, though (which has paved the way for the private student loan industry to flourish). With federal student loans, students can borrow $5,500, $6,500, and $7,500 per year for the first, second, and third years (and beyond) of undergraduate college education, respectively. Only $3,500, $4,500, and $5,500, respectively, of that yearly amount can be in subsidized loans. (The government pays the interest on subsidized loans while the borrower is in school.)

Prospective borrowers need to fill out the Free Application for Federal Student Aid to determine their eligibility for subsidized and unsubsidized federal student loans.

Federal Subsidized Loans on the Chopping Block
Federal subsidized loans, such as subsidized Stafford or Perkins loans, can help make the cost of borrowing more affordable for students. With these subsidized loans, the Department of Education pays the interest, provided the student is in school at least half time and for a limited grace period after leaving school. With other types of loans, interest begins to accrue immediately. Subsidized loans are only available to students with a financial need, and there are limits to how much a student is eligible to borrow each academic year. 

Subsidized student loans' days may be numbered, though: In its proposed 2018 budget document, the Trump administration proposed eliminating the subsidized student loan program. This is a hotly debated topic. Some argue this will make college even less affordable for those who can least afford it in the first place. 

But some defend the cuts by saying government subsidized loans are likely exacerbating the problem of escalating college prices in the first place, and doing away with them could result in colleges lowering tuition, or at least stemming the rate of price inflation in an effort to make colleges more affordable to more students. 

Mark Kantrowitz, a student financial aid expert and publisher of Cappex.com, says in order to truly make college more affordable to lower-income students, federal money would be better spent on Pell grants (which do not require repayment) than on subsidized loans, anyway.

"Subsidized loans do not lead to improvements in college access and completion," he said. "The money would be more effectively spent if it were devoted instead to increasing the average federal Pell grant. Increasing the federal Pell grant will increase the number of low-income students enrolling in college and graduating from college. It will also decrease debt at graduation."

In reality, the 2018 budget proposal contains mixed news for the Pell grant program. Though it maintains the current funding level for the Pell grant, the maximum award going forward would be flat, with no inflation adjustments. It also reallocates $3.9 billion in surplus funding away from the Pell grant program. The good news, though, is that the government has proposed restoring the year-round Pell grant, which it says would provide an additional $1.5 billion for students taking courses over the summer. 

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