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Student loans: A good deal

America is awash in debt. The consumer-driven economy is driving consumers into bankruptcy, the average household owes more than $10,000 in high-interest credit card debt spanning six or more credit cards, and the Goverment recently announced that our national savings rate was negative. (Not that the Government has room to talk; the Government is exceeding its income so much that the new exciting goal in Washington is just to cut the deficit in half by the end of the decade.) Amidst this sea of splurge-spending that has seen consumers trade their home equity in to pay off credit cards only to max-out those same cards in the same calendar year, there is a curious reluctance on the part of the American populace to borrow money for higher education through the Stafford loan program. In fact, the same students who eagerly sign up for card after card just to get free tacky t-shirts they'll never wear complain about the amount of student loan debt that they'll have when they graduate. If only all of America's financial troubles were linked to student loans! These loans aren't as bad as parents and students seem to believe.

In fact, they're among the best deals available today. Here's why. Attractive Rates For the last decade, interest rates on Stafford loans have been exceptionally low, getting down to as little as 3% or less during some years. The Stafford loan rate has traditionally been variable, fluctuating based on the prime rate; by law, however, the rate has been capped at less than 9%. That means that even in a bad year, the gross interest rate paid on those funds is a lot better than the rate on most credit cards (which average around 17% and can go upwards of 25%).

Moreover, even those attractive rates only apply to the unsubsidized portion of Stafford loan debt while a student is in school (defined as enrolled half-time in a degree-seeking status). Depending on a family's financial situation -- and the terms are pretty generous here, too -- a portion of the money for which students are eligible may be subsidized. The Government pays the interest for the subsidized portion of the loans while students are enrolled. The amount that you can borrow is capped by school year (Fr., So., Jr., Sr., and Graduate) as well as a student's dependent status with regards to his or her parents, but for a quick example, let's assume that you are a graduate student who borrows the maximum annual amount of $18,500 and qualify for the maximum subsidized amount of $8,500. Your interest rate is 8.5%, but while you're in school, you only pay that 8.

5% on the $10,000 in unsubsidized loans. That means the effective interest rate for the entire $18,500 is only about 4.6% while the borrower is in school. Attractive Terms In addition to being relatively cheap versus other forms of borrowing, Stafford loans offer extremely attractive terms. No payments at all are required while the borrower is in school, although students may choose to pay the unsubsidized portion of their interest to reduce payments later on. When he or she does leave school and repayment begins, there are several payment options, including a graduated pay scale that assumes a low initial income growing over time or an extended term that gives up to 30 years to pay off the debt. And if the borrower decides to return to school? The loan can be deferred again as in-school status. Try telling a mortgage company that you won't be living in your house for a few months so you'd like to defer the mortgage! Consolidation At the moment, consolidating student loans remains a very powerful option for borrowers. When loans are consolidated, they shift from a variable interest rate to a fixed rate calculated as a weighted average. The average is based on the rates of each loan consolidated -- and someone who consolidated once could borrow more and then consolidate again.

(Consolidation loans can also be deferred if the borrower returns to school.) Consolidation was particularly valuable in the early part of the decade when interest rates bottomed out, giving students a chance to lock in a fixed rate of 3% or less for the life of the consolidated loan. These days, with interest rates edging up, the locked-in rate would probably be between 5% and 6%. Tax Advantages The last of the four key strengths of student loans is their tax treatment. Interest paid towards student loans is tax-deductible up to a certain cap. While it does phase out based on household income, the phase-out levels are fairly high and most likely don't affect many recent graduates (especially married couples). What about grants? In their eagerness to shun loans, Americans clamor about grant programs, particularly the Pell program. Grants are basically free money; the funds are given based on certain criteria but generally do not have to be repaid. Don't get me wrong, either: if someone offers you a grant, take it. That being said, education is an investment in your own future.

Sure, the nation has a vested interest in having an educated population, but that interest is only met if its citizens succeed in the courses that they take and actually get educated. Grants are fine as part of the mix, perhaps, but anyone who is planning to attend a college or university should go into it confident that he or she will make enough money when it's all over to be able to repay money borrowed to finance the costs of education. I understand that there are exceptions -- some of the arts, in particular, never pay well -- and these are areas where grants make sense (though even here, I favor merit-based scholarships). Too often, people are going to college without the slightest idea of why they are there and failing to learn anything at all. If they do that with borrowed money, fine; if they do it with tax dollars given in the form of grants, perhaps not so fine. Either way, grant money rarely covers the entire cost of education. That takes us back to Stafford loans. Changes are coming (but it's still a good deal) One little-noticed aspect of the recently passed Deficit Reduction Act is a provision that changes Stafford loans from variable rates to a fixed rate of a little under 7%. The Government likes this change because it makes loan interest predictable.


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