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Student loans

If your child is headed to college, you may need a student loan to cover expenses. Fortunately, there are many government-sponsored and private sources of funding to assist you.

Strategy: Before borrowing, explore all scholarships or grants available. This education assistance need not be repaid. No matter how favorable loan terms may be, they're not as attractive as free money!

Finding out about student loans

Locating the right loans and loan application process can be confusing. Some loans are limited to families with low income. Other loans are more widely available. Interest rates and repayment terms vary widely.

Many high schools have programs for parents about the college application process, including student loans. College placement offices in high schools also contain materials to assist you.

Obtain a free guide from the US Department of Education called The Student Guide: Financial Aid, 2002-2003 (www.ed.gov, 800-872-5327 or 800-848-0978).

Two key commercial guides are:

• College Money Handbook (Peterson's Guides)

• The Scholarship Book (Prentice-Hall)

Online sources of information about financial aid, including scholarships and loans, are:

• The College Board (www.collegeboard.com)

• FastWEB (www.fastweb.com)

• FinAid (www.finaid.org)

• Octameron Associates (www.octameron.com)

• WiredScholar (www.wiredscholar.com)

The federal government's Direct Loan program: Three types of loans are available through the Direct Loan program:

• Direct Stafford/Ford loans (subsidized loans) are available to those in financial need. The amount generally is limited to $2,625 for the first undergraduate year, $3,500 for the second year and $5,500 for the third and fourth undergraduate years (limits are higher if parents can't qualify for Direct PLUS loans, below).

• Direct Stafford/Ford loans (unsubsidized loans) are available without regard to financial need. The student is responsible for the payment of all interest charges on these loans.

• Direct PLUS loans are made to parents of dependent children. Loan limits are up to the cost of attendance, less any other financial aid.

Note: Direct Consolidated Loans are merely a combination of two or more federally sponsored education loans. This is a repayment plan rather than a type of loan.

Other loan sources: You're not limited to borrowing under the Direct Loan program. Consider:

• Federal Perkins Loans to low-income students. No repayment is required while the student is in school. Interest, at a very low rate, accrues during this time and for nine months following graduation.

• Bank loans from commercial institutions. Most banks provide loans to students and their families for higher education at lower interest rates than other commercial loans.

Strategy: Look for a bank loan that will be sold to the Student Loan Marketing Association (Sallie Mae). These loans encourage prompt repayment by refunding all but $250 of the loan origination fee if the outstanding balance is repaid within 24 months. For repayment within 48 months, the interest rate drops by 2%. And if the repayment is automatically debited from your bank account, you'll receive an immediate reduction of 0.25% off the interest rate. For further information about Sallie Mae loans, call 888-272-5543 or visit www.salliemae.com.

Strategy: Consider the federal work-study program as an alternative to borrowing. On- or off-campus employment, often at minimum wage, can supplement scholarships, grants and loans. Bonus: Your child may gain valuable work experience as well.

Loan application process

To apply for student aid, which includes loans, you'll be required to complete the Free Application for Federal Student Loan Aid (FAFSA). You can obtain the FAFSA form in several ways:

• From the student's high school guidance or college office.

• From the US Department of Education (www.ed.gov, 800-433-3243).

How much aid (in the form of scholarships, loans, work-study, etc.) you'll receive depends on your (and your child's) financial information. This information gives rise to your expected family contribution (EFC)-what you are expected to devote of your assets and income to the payment of college costs. Here are some guidelines to keep in mind:

• 5.65% of your assets are presumed to be available for the payment of college expenses. Funds in your retirement accounts are ignored. Your income is also taken into account.

• 35% of the assets in your child's name are presumed to be available for the payment of college expenses. Earnings are also factored in.

Repayment

Federal student loans are usually repaid in monthly installments over a period of up to 10 years; the term depends on the amount borrowed. Extended repayment terms of up to 30 years are available under certain conditions. Income contingent repayment plans base the monthly required payment on income and provide for repayment in up to 25 years.

Commercial loans have their own repayment terms spelled out in the loan agreement. But all loans, government or commercial, can be repaid as quickly as you desire, cutting interest costs that would otherwise accrue.

Strategy: Explore debt forgiveness options. If your child works in certain locations-for example, an Indian reservation or the inner city-for a set period of time, some or all of the loan may be forgiven. Bonus: This debt forgiveness isn't taxable income.

Tax treatment of interest

While interest on consumer debt (other than a home mortgage) isn't deductible, a special rule allows for a limited write-off of student loan interest. You can deduct interest up to $2,500 per year. This deduction is an "above-the-line" deduction that can be claimed whether or not you itemize other deductions. It applies only to qualified higher-education expenses-tuition, fees, supplies, room and board-at a qualified higher-education institution attended on at least a half-time basis.

Caution: The full $2,500 deduction can be claimed only if your adjusted gross income is below a certain level; $50,000 for singles or $105,000 on a joint return in 2005 (a phase-out of the $2,500 limit applies to income up to $65,000 for singles and $135,000 on a joint return). But if the loan was taken out in the student's name, he may have a modest AGI in the first several working years and be able to deduct interest on his loans.