Sounds like a trick question, doesn’t it?
I’ll take no debt whatsoever for $800, Alex.
No debt, however, is not an option for many young professionals. In fact, most will carry both mortgage and student loan debt just like I did for the first half of my professional career. I am happy to say we are now completely debt-free, but it didn’t happen until I was nearly 40 years old.
There are pros and cons to carrying these different types of debt, and one or both could come with tax advantages unlike most other forms of debt.
Nchum Felicita of The College Monk compares the two with a focus on student loans in today’s guest post.
Loans serve as monetary assistance when someone is in need of money.
A loan that helps you make a productive move and lead you towards success in life is considered as “Good debt”. Other debts that are used for a short time necessity are considered as “Bad debts”.
Mortgages and student loans are usually considered to be a good debt, whereas credit card debt, consumer debt, and auto loans are a few bad debts. Here, we will be focusing more on good debts. Let’s go through a quick comparison between mortgage debt and student loan debt.
What is a student loan?
A student loan is financial assistance from the federal government, an organization, or a financial institution as a way to help pay for your school. They are usually used to cover the cost of tuition, fees, books and supplies, and living expenses.
What is a mortgage?
We can call a mortgage a debt instrument that is secured by the collateral of particular real estate property, where a borrower is bound to repay with a fixed number of payments.
Mortgages are used by individuals and businesses when they make large real estate purchases without paying the complete price up front.
How are Interest-rates set?
Consider the two areas below:
For Student Loans:
Congress sets the interest rates for federal student loans. The federal interest rates are usually fixed.
Private lenders set their own interest rates on the student loans that they provide. Private banks offer both fixed and different interest rates. The fixed interest rates stay the same for that person as long as you carry the loan and still have debts to pay back, whereas variable interest rates change with changes in market conditions.
The interest rates for mortgage debts are always changing. Private lenders change the interest rates continuously based on the changes in the debt markets. For example, a conventional 30-year fixed-rate mortgage can change with respect to the 10-year Treasury yield.
It should be noted, the student loan interest rates are generally higher than a 30year fixed-rate mortgage.
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Are there other options before taking out a student loan?
For a student, student loans are the last and final way of finding help to pay their college tuition and other expenses. The best possible options to pay your expense include:
Scholarships and grants
Before trying for student loans, go for grants and scholarships. Scholarships are the financial support given to a student based on academic achievement and are not usually based on the financial need.
Opting for student loans is advised only if you do not qualify for any grants or scholarships.
Go for a college offering work-study program. The work-study program is also one of the possible alternatives where a college encourages students to work for the institution while also attending college.
In most work-study programs, you keep what you earn with your work, your paycheck will not affect financial aid eligibility, the reward can be more than just financial, and work can often be scheduled according to the student’s routine.
File for federal aid as possible using old tax returns
Filing the FAFSA can be a particularly important way for students whose families have low-income or cannot support to pay for college. In such cases, students may be eligible for the federal Pell Grant Program, which is awarded to students who need financial need and do not have to be paid back.
Filing the FAFSA may also be required for other financial aid that students get from the desired state/college plan tend to give.
Students can utilize “prior-prior year” tax return to complete their FAFSA.
For example, a student filing for a FAFSA in 2019 can refer details from their 2018 federal tax return. This helps a student to complete FAFSA easily and understand financial aid options, instead of having to wait on more tax returns.
Understanding different types of loans
Federal loans are the best as they offer low fixed rates. They offer provisions for deferment, a time duration where the interest of your loan does not accrue. They can also offer a grace period before your repayment period starts and forbearance, which is a time where you might be allowed to postpone paying if you have financial problems in making payments, but interest accrues. Federals loans have various repayment programs such as Income-based repayment (IBR).
Seek options for subsidized and unsubsidized loans.
Subsidized loans are supported by the government, and they do not accrue interest if you are still studying in a degree program.
Unsubsidized loans are available based on your financial need and accrue interest right away you take the loans.
Private loans sometimes have very high-interest rates and their rates tend to fluctuate. They do not allow government repayment program participation.
Understand the results of too much debt.
Be very cautious before applying for loans, and realize how much your borrowing can impact later on.
Learn more from the National Student Loan Data System for your personal federal loans. Over 1 million borrowers in the U.S. are presently in default as they have failed monthly payments for nine months.
Defaulting on student loans have very serious consequences on your credit status, and can block you from receiving further financial aid. The federal government may garnish part of your income or withhold your tax refund. It also has a profound impact on your credit score and can prevent you from qualifying for a mortgage to purchase a home.
Learn your repayment options
Your future income can influence your ability to pay back loans and the programs you have available to you. Plans based on income level and loan forgiveness programs are options that can help student borrowers.
Borrowers can try for income-driven repayment plans. Income-driven repayment plans allow borrowers to pay between 10%-20% of their wages towards student loans, rather than payment on loan size.
Public Service Loan Forgiveness Program such as teaching or not-for-profit organizations might be an alternate option.
The College Monk has an extensive list of college scholarships available. Most people believe that they need to fit a particular profile to get a scholarship. With the variety of scholarship options out there, you should be able to find a scholarship that suits your profile best.
Mortgages don’t have as many alternative options, obviously.
Factors to consider while managing your student loans
Refinancing is a major factor to be considered while managing loans. If you are struggling to make payments towards your loans due to high-interest rates, refinance them through a different lender who can offer a lower interest rate. There are many private lenders and credit unions that offer refinancing for mortgage debts, as well.
Student loans can also be refinanced through private lenders and credit unions. But you must remember that when you are refinancing your current federal student loans through a private lender you may lose the benefits and privileges that you hold on that loan.
[PoF: Do NOT refinance if you are pursuing PSLF or are currently receiving interest-free forbearance. Here are the latest refinancing rates and cash back offers for those who are not in either of those boats.]
Managing loans when bankrupt is hard. Both mortgage and student loans allow you for loan discharge on bankruptcy for valid reasons.
Keeping track of the loans
It is very important to keep track of your loan balances and payments. Any loan provider expects the borrower to make on-time payments towards loans. You have to be careful in making payments at the right time, and auto-pay can make this easier.
You may keep track of the loans and due dates by contacting your lender or servicer. Student loan servicers are the best point of contact for borrowers in helping them solve their issues related to student loans.
Make regular monthly payments towards the loans to reduce the burden on you. If you fail to make payments towards a mortgage, you may end up losing the property that you used as collateral.
With student loans, you may end up defaulting on your student loan if you don’t make regular payments on time. The Student Loan borrower may get grace periods like deferment and forbearance during which loan repayment can be suspended. But with mortgages, such benefits are rare.
Lenders providing mortgages and student loans offer different repayment plans for the borrowers so that they can choose the best that suits them.
Federal loans offer benefits only to a certain point
Federal loans are typically the lowest-cost borrowing options for college but refer to a hard cap on how much the student is taking loans. Direct loans have low fixed rates since July 2019, 4.53% for undergraduate students, and your credit isn’t affected while applying. Also, no cosigner is needed.
If your income after graduation is not sufficient to make payments on the standard 10-year repayment plan, you can enroll in an income-driven repayment plan. Depending on your income, any remaining loan debt may be forgiven after 20-35 years. [PoF: In this case, the amount forgiven is taxable.]
Similarly, if you work in public service jobs, your loan debt will be forgiven after 10 years of timely payments. [PoF: and PSLF forgiveness is not taxed, a noteworthy distinction.] Plus, if you qualify for need-based federal loans, you won’t be accruing any interest while you study.
Financial experts usually advise taking federal direct loans before applying for private loans.
Federal loans may not be enough
As federal loans have annual and borrowing limitations, they are often not enough to support your loan balance, and parent PLUS loans or private loans can help.
The maximum limit in direct loans for your overall undergraduate degree is $31,000. If there is more financial need, parent PLUS loans could be one way to cover it. The PARENT plus would charge a fixed interest rate of 7.08% and have a loan disbursement fee of 4.236% for the year of the 2019-20 year. Taking private loans in addition with Parent PLUS loans, you can borrow up to 100% of the cost of attendance.
Save with lower interest rates from private loan offers
Parents who have good credit as cosigner get lower fixed or variable rates as compared to PLUS loans along with a private lender such as CommonBond.
Interest rates depend on the cosigner’s credit score, their repayment method, and choice of fixed or variable loan.
Private loans also offer safety like forbearance, grace period after graduation, and instant cosigner release.
Having a cosigner is a serious deal, especially for a student with loan debt. They can help you get a better interest rate
However, if a student is unable to pay back the loan, the cosigner takes over the payments. If the cosigner is also unable to pay it back, both borrowers’ credit scores are affected negatively.
Mortgages are usually meant for those who can bring in collateral into their loans. There are risks of losing your collateral property when you cannot repay your mortgage debts. Student loans are solely meant to support someone to continue their studies and achieve their goals, and there is typically no collateral.
Though student loans are typically more expensive when compared to a mortgage, it helps you to get a higher education through which you may be able to find a good job and in turn, will be able to repay your debts over time. It is advised to explore all the student loan options available before you settle on the best student loans suited for you.
Author Nchum Felicita of The College Monk is a personal finance enthusiast who is doing her best to help others navigate the complicated waters of educational debt.
If refinancing is the best option for your student loans, please consider signing up via my links, which you can find in this post and on my Student Loan Resource Page, which has links to dozens of great articles on the topic. I’ll donate $50 to a charity of your choice if you can show that I was credited as your referral source.
If you would like to consult with a former Vanguard bond trader who has consulted on over 1,000 individual’s and couple’s student loan scenarios, or you would like a second opinion, consider a consult from Travis, the Student Loan Planner.