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The Intricacies of Loans and Tax Credits

There are many different types of student loans available. Each has their own benefits and downfalls and it is important that you research thoroughly before deciding on any one type.

The following series of articles analyze the various kinds of loans you can apply for, as well as helpful educational tax breaks and interest rate deductions that may influence your overall school cost. Further, throughout the articles you will find helpful links to private loan lenders, government loan sites, and further information on tax credits.

School Sponsored Student Loans

Despite all the hoopla and media coverage about private and government-sponsored student loan programs, it turns out the most common type of financial aid given out to university students is neither of the options mentioned above. These days, school-sponsored student loans are actually the most common form of student aid in many parts of the country, as universities dole out billions of dollar each year to help accepted students attend courses at their school.

These school-sponsored loans—which are also known as university loans or institutional loans—have many benefits and drawbacks. However, because they vary so greatly from university to university, it can be difficult to obtain nationwide statistics that pinpoint just how common they are. Many universities do not advertise school-sponsored loans on their websites, and require students to speak with a financial aid advisor to find out which options are available.

Oftentimes, information about institutional loans is located within the financial aid award offer that comes along with acceptance to the university. In addition to grants and scholarship options, many of these award offers will feature information on student loans—including how much students are eligible to take out and when those funds must be repaid.

The amount that a school has to offer its students can vary greatly from year to year, depending on how the university's endowment is faring, and the terms of the loans—including lifetime, repayment rules, and interest rates—can oftentimes be strikingly different as well. Luckily, schools are typically on the side of students more so than some other private loan lenders, which means that they generally have more forgiving policies that allow borrowers to pay back more demanding creditors first.

To check out the other benefits and drawbacks of school sponsored student loans, we compared the pros and cons.

Pros

1. School sponsored loans are generally easier to obtain than those from private lenders, since the university is less likely to take current income levels into account when determining your eligibility.
2. Many school sponsored student loans come with lower interest rates—especially those that are intended for short-term use. In fact, some universities have been known to offer short-term loans with rates as low as 1%, even though the majority of these loans range in rates from 3% to 10%.
3. Students can get access to the money they request through a university or intuitional loan more quickly than with traditional student loans. Because of this, school sponsored loans are a good option for immediate, short-term financial needs such as books or housing costs that must be paid up front.
4. For borrowers with student loans from multiple lenders, school sponsored loans can be preferable because they allow you to prioritize your loan payments and pay back other lenders—such as the federal government, for those who took out Stafford loans—before paying back the school.

Cons

1. Students usually cannot take out as much money in school sponsored loans as they can in government or private loans. Thus, for most students, university-sponsored loans serve as a supplement to their total financial aid package and not a sole source of educational money.
2. These types of loans can be difficult to find out about, especially if information was not included in your original financial aid offer from the university. Rather than being able to search online, most students are required to speak with a financial aid officer in person to learn more about their options.
3. Despite relaxed eligibility requirements, many universities still require a cosigner on the loans they offer students. Thus, if you do not have a parent or guardian who is willing to take on the responsibility of paying back this loan in the event of a default, then you will be unable to obtain a school sponsored loan in many cases.
4. School sponsored loans cannot be consolidated with federal student loans, which can make repayment slightly more complicated once the post-graduation grace period is over.

Article Resources:

FinAid
Federal Student Aid FAFSA4caster

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Government Sponsored Student Loans

Government-backed student loans are one of the most popular forms of financial aid available, and there is a good reason why. Loans backed by the federal and state government are plentiful, straightforward, and easily available for the majority of students attending accredited universities.

Although the specific amounts that students are eligible to take out depend on the type of loan, most students at undergraduate institutions are able to pay for the majority of their education costs with the help of government sponsored loans. Not only that, but the federal government's generous subsidy program will effectively pay the interest on many borrowers' loans while they are still enrolled in school. It's hard to get much better than that.

Of course, government loans have their downsides as well. For one, students must be actively enrolled in an accredited university to qualify for them, which means anyone attending a university that has lost its accreditation could be left without a way to pay. Additionally, most federal loan programs have financial caps limiting the total amount that a student can borrow based on the school's preset cost of living index.

To determine which government sponsored loan is right for your situation, here are the three most popular types.

Stafford Loans
As the most popular type of federal student aid, Stafford loans are a form of government award money that all FAFSA filers are eligible to apply for.

The main benefit to Stafford Loans are that they can be subsidized—meaning the government will take care of the interest rate while the student is in school—or unsubsidized—meaning the interest that accrues during schooling will be capitalized upon graduation. While unsubsidized Stafford loans currently have a fixed interest rate of 6.8%, the federal government has instituted a reduced rate for students with subsidized loans based on what year they started their undergraduate education.

The biggest drawback, meanwhile, is that these loan amounts can be severely limited. The amount that a student is eligible to take out in subsidized Stafford loans each year can sometimes be as low as $3,500, with a maximum undergraduate debt load of $23,000. For students attending pricey private institutions, that amount may not even cover one year of tuition and fees.

Perkins Loans
Perkins loans are a form of federal aid given to students who can demonstrate an "exceptional" financial need at participating institutions.

Like Stafford Loans, the main benefit of Perkins loans is that they can be subsidized, which means the government will be paying the interest for as long as the borrower is enrolled in school. In addition, Perkins loans are usually seen as favorable to Stafford loans because they offer a generous nine-month grace period and an interest rate of only 5 percent.

The downside to Perkins loans is how difficult they can be to get. To qualify, students must prove that they have a financial need above and beyond that of an ordinary student. Also, Perkins loans may not cover all costs, since undergraduate students are limited to receiving only $5,500 per year, or $27,500 in sum, in Perkins awards.

PLUS Loans
When other loan types are not enough to cover a student's full educational costs, the federal Parent Loan for Undergraduate Students (PLUS) program is available to help undergraduate students in need. This program gives parents and graduate students themselves a way to borrow money for education costs.

Fixed interest rates and moderate credit checks give parents and graduate students a great chance at qualifying for PLUS loans. For many, this type of aid may be the last resource available when other programs offering financial award money have been tapped out.

Unfortunately, unlike other loans available PLUS loans do not offer a subsidized option and payments must start being made just 60 days after the funds have been dispersed. There is no deferment period with PLUS loans, and parents may not consolidate these loans together with any Stafford and Perkins loans that have been given out in their child's name.

Article Resources:

Stafford Loans
Perkins Loans
PLUS Loans

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Privately Sponsored Student Loans

Navigating the world of privately sponsored student loans can be a tricky endeavor.

On the upside, there is essentially no limit to the amount that can be borrowed, which can serve as a major benefit to students looking for a way to fill in the gaps between the amount of financial aid they have been awarded and the amount it is going to cost to attend their intended university.

On the downside, however, privately sponsored student loans can be difficult to maneuver once the repayment process begins, with many coming with a higher interest rate than the government and institutional loans many students get from their financial aid office. A higher interest rate can drive up the total cost of the loan by a substantial amount, depending on the lifetime of the debt and how quickly it is repaid, which is the main reason why students are generally advised not to turn to private loans unless they need to.

No matter what your personal feelings are on may be, though, the truth is that loans obtained from private lenders are necessary for many students. Because the funds that the government allows students to borrow are frequently not enough to cover the full cost of a college education, privately sponsored student loans—also known as private education loans or alternative education loans—can be a student's last resort when it comes to finding the money necessary to stay in school.

For the best chances of finding the right lender, the right conditions, and the right loan for your specific situation, here is information, including pros and cons, about the most popular types of privately sponsored student loans.

Sallie Mae Private Student Loans
Once federal and state educational loans have been maxed out, Sallie Mae's private student loans are oftentimes the next step for students and their families. However, because these loans are based on a student's creditworthiness rather than his or her financial need or academic eligibility, it may be necessary to find a parent or guardian who is willing to cosign on one of these Sallie Mae loans in order to qualify.

Wells Fargo's Collegiate Loan
Like other private loans, the Wells Fargo option requires that students have either excellent credit or a cosigner in order to qualify to receive money. For those who do meet the eligibility requirements, though, the Wells Fargo programs offers a variety of benefits to students including the chance to potentially lower your interest rate by .50% once the bank has verified your graduation. In addition, lower interest rates are available for those who set up automatic payments from their bank accounts, as well.

Chase Select Private Student Loans
Although it is technically a private loan, borrowers interested in taking out a Chase Select loan may still be required to fill out a FAFSA in order to determine eligibility. These specific loans are designed to cover educational costs including tuition, living expenses, books, and even computers, and students are not required to make any payments for as long as they are enrolled in school.

Citibank CitiAssist Loans
CitiAssist loans are designed to cover all the expenses that aren't covered by a traditional financial aid package, and feature automatic deferment while students are still enrolled in school as well as flexible repayment packages for once they graduate. The interest that accrues on CitiAssist loans may be tax deductible, and students can find out within an instant whether or not they have been approved just by checking online.

No matter which type of student loan you choose to go with, it is important to read the fine print and learn as much as possible about the rules and restrictions before singing on the dotted line.

Article Resources:

Sallie Mae
Wells Fargo
Chase Student Loans
Student Loan

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Student Loan Tax Credits

As a way to lessen the financial burden that paying for a college education can place on students and their parents, the federal government has instituted a number of tax credits and incentives. Among the various options out there, tax credits are widely considered the most favorable option.

Unlike deductions and other incentives, tax credits can actually lower a person's tax bill by the exact amount of the credit. Therefore, if you or your family qualifies for a $2,500 tax credit, for example, then your actual tax bill due at the end of the year will be $2,500 less than it would have been otherwise. That can oftentimes lead to a bigger tax return. Alternatively, a $2,500 tax deduction would just reduce your taxable income by $2,500 rather than shaving that amount off of your actual bill.

Because these credits are so advantageous to tax payers, they are almost always more difficult to get. Specific rules and requirements vary by the tax credit, but most include some type of income cap that precludes families from qualifying for the credit if they earn too much money.

Among the most popular of the student loan tax credits currently available are the Hope tax credit, the Lifetime Learning tax credit, and American Opportunity tax credit, which was just recently introduced by the federal government.

Hope Tax Credit
By far, the most common tax credit for students and their families to take is the Hope credit. Using this, families can take up to $2,500 per student, per year off of their tax bill for each qualifying student in their family who is still listed as a dependent on tax documents.

Recent changes to this credit have increased the amount that families can receive—from $1,800 up to $2,500 for people filing their 2009 and 2010 returns—and an adjusted length of time that students are parents can file for the credit. Possibly the more important new change, however, is the fact that up to 40 percent of the money a family claims through the Hope credit is now "refundable," which means they can actually get a check in the mail above and beyond what they originally paid into the system in withholding taxes.

Restrictions on the Hope credit, however, include a limited period of time when students and their families are eligible. In addition, anyone with a felony conviction for possessing a controlled substance is restricted from applying for this credit. Finally, the credit is reduced for parents with a modified adjusted gross income of between $80,000 and $90,000, or $160,000 and $180,000 for those who file a joint return, and any families earning over this amount may not qualify for the credit.

Lifetime Learning Tax Credit
For students who are enrolled in college but are not taking enough courses each semester to qualify for half-time or full-time status, the Lifetime Learning credit might be a better option than the Hope credit. This tax incentive allows students or their parents to take a tax credit of up to 20 percent off of the first $10,000 they pay toward qualified education expenses each year.

The latest changes to this credit have been a newly announced income increase that allows more families to take part. Now, filers earning up to $50,000, or $100,000 for those filing joint returns, are eligible to take the full credit. It should also be noted that lifetime learning credits can be claimed for as many years as the student is still enrolled in school, which is a real benefit to families with students who are enrolled in college for more than four years.

American Opportunity Tax Credit
Because it is still relatively new, less is known about the American Opportunity credit. Because it is essentially an expanded version of the popular Hope credit, the American Opportunity credit has many of the same restrictions. As an advantage, though, this option gives people the chance to claim the credit for four years of a student's education, rather than just two.

For parents who previously thought they had maxed out their educational tax incentives using the Hope credit for the first two years of their child's education, the American Opportunity credit can be an unexpected surprise that allows them to take another $2,500 off of their tax bill for the third and fourth year of their child's undergraduate schooling.

Finally, the income limits to file for an American Opportunity credit are higher than those for the existing Hope and Lifetime Learning credits, which makes this an especially attractive option for higher earning families.

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Student Loan Tax Deductions

Whether you're a college student, a recent graduate, or the parent of a student who's paying your child's way through school, a number of federal incentives and deductions exist that can save you a bundle come tax season.

Although deductions tend to take slightly less money off of a filer's overall tax bill than some other incentives—such as tax credits, for example—they are generally easier to qualify for and receive. Especially for families earning incomes that are too high to qualify for educational tax credits, these student loan deductions can be key in reducing overall tax liabilities for the year.

Essentially, tax deductions are a type of tax incentive that lessens the filer's taxable income. So, for a person who makes $50,000 in gross income a year and files for a $2,000 education-related tax deduction, the amount of taxable income would be brought down to $48,000 in that year. The specific amount that a tax deduction will help you save in federal taxes depends largely on your current income and tax bracket, among other factors. However, one thing that remains constant is the ultimate value these deductions bring to tax filers.

Currently, the most common of these tax deductions for students and parents to qualify for are the Student Loan Interest Deduction and the Tuition and Fees Deduction.

Student Loan Interest Deduction
For students who need to take out a student loan in order to pay for their education, the IRS offers a student loan interest deduction that is designed to lessen the burden during repayment. Depending on your current income level, you may deduct up to $2,500 in interest that has been incurred from an eligible student loan in the past year.

There is no requirement to itemize deductions in order to qualify for this deduction, which makes it easier for obtain for many parents and adult children. The only catch here is that the loan itself that was originally taken out must have been used to pay for "qualified" higher education expenses, and nothing else.

Recent changes to the tax code have actually increased the number of people who are eligible to receive the student loan interest deduction, by upping the income caps placed on students and their families. As of 2009, tax filers may tax take all or part of the $2,500 so long as their adjusted gross income does not exceed $75,000 or $150,000 for couples filing a joint tax return.

Tuition and Fees Deduction
For individuals and families who choose not to take the Hope credit, Lifetime Learning credit, or the American Opportunity tax credit for one reason or another, the federal government's tuition and fees deduction can be yet another way to cut down on the overall income liability and save money come tax time. Qualifying individuals or families are eligible to deduct up to $4,000 of their taxable income by using this deduction.

In addition to strict income requirements, which say that individual filers earn a modified adjusted gross income of $80,000 or less to qualify, the tuition and fees deduction can only be taken based on the amount of "qualified educational expenses" the filer incurred over the course of the past year.

Any educational expenses that have been paid with tax-free funds—such as Pell grants, tax-free scholarships, Veteran's educational assistance, and things of that nature—must be deducted from the amount of qualified expenses. Other typical education-related expenses, such as health insurance and living costs, should not included in this deduction, either.

For more information on these tax deductions or any other educational tax incentives, visit the IRS homepage.

Article Resources:

IRS.gov

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College Savings Accounts

Next to saving for retirement, paying for college is likely to be your biggest financial challenge. There are two primary college savings accounts that help families save money for education: A 529 college savings plan and the Coverdell Education Savings Account. Read on to discover what these accounts are and how they can be tremendously beneficial.

The 529 Plan
Named after Section 529 of the Internal Revenue Code, the 529 plan is a tax-advantaged investment account designed as a simple way for families to set funds aside for future college costs. The plan is operated by a state or educational institution which has no bearing on a student's future school choice. In other words, California residents can invest in a Colorado 529 plan and send their student to college in Arizona without penalty. Every state offers at least one 529 plan, but keep in mind that these plans do vary by state.

529 plans fall into two categories: savings plans or prepaid plans. 592 savings plans operate in much the same way as a 401K. The account owner will be offered several investment options from which to choose, and the account will fluctuate in value based on the performance of the option you select. Prepaid plans let account owners pre-pay the cost of an in-state college education. Of course they can be converted if the student chooses to attend an out-of-state or private college.

Among the benefits of a 529 plan include the fact that the student does not have control of the account. If the child doesn't want to go to college, the account owner can roll it over to another family member. What's more, anyone can contribute to the 529 plan—there are no limitations on a person's income that might undermine their ability to contribute. Most states set no age limit for when the student's money must be used, and if the student receives scholarships, the unused 529 plan money can be withdrawn from the account without incurring a penalty.

Coverdell Education Savings Account
A Coverdell Education Savings Account is another tax-advantaged investment account designed to help parents and students save for education expenses. The beneficiary of the Coverdell ESA account must be under age 18.

Like a 529 plan, money deposited into the savings account can grow tax free until distributed and remain tax free at the time of distribution as long as they are used for qualified educational purposes. These purposes include room and board, tuition and fees, supplies, books, and equipment. However, if money is withdrawn and used for purposes other than an eligible college expense, it will be subject to income tax and an additional ten percent tax penalty on earnings. Additionally, money in both a 529 plan and a Coverdell ESA is not considered the beneficiary's money when he applies for federal financial aid as long he is not the owner of the account. This effectively increases the child's potential for financial aid.

Unlike a 529 plan, Coverdell Accounts cover expenses of primary and secondary school, not just college and secondary. In this way, Coverdell Accounts allow families to save money a broader range of educational purposes.

If you are considering a 529 plan or a Coverdell Account, consider the fees charged by each plan. Find out specifically what educational expenses are covered by the plans. Determine which colleges and universities participate in the plans. Answering these and other questions will help you choose which college savings account is right for you.

Article Resources :

Cornell University Law School: Coverdell education savings accounts
IRS.gov: Coverdell Education Savings Accounts
U.S. Securities and Exchange Commission: An Introduction to 529 Plans

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