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What about hedging and applying for a mix of loans (GradPlus and private)? I thought about this, but haven't spent any time researching the implications yet. Are the private loans limited to the COA generally or is it just based on your credit inquiry?
I was thinking about doing the hedge thing too. The idea would be to borrow say 25% of your total loans privately, then if rates went through the roof, you could pay those off first. Or, you could do most of your private borrowing in your second year, lowering your overall exposure.
The thing is, when you start to do that, you reduce the total benefit you'll get from using private loans. At some point, its not going to be worth all the effort to save $2000 if you're also taking on the risk of rising interest rates.
I'm pretty sure you can't borrow above the COA on any loans, at least not without withholding info from the lender.
I also agree with jb32 that the risk of rapidly rising interest rates is probably higher now than any time in the last twenty years. I'm going to stick with Stafford and GradPlus and try and pay off the higher interest rate loans ASAP after graduation. In the end, the added cost will be worth the lower risk.
I'll start, here's a model from a guy whose never done any financial models.
I assumed you make one payment at the end of each year, paying off the interest for the entire year and 20% of the principle. This has the following implications:
- total interest paid is pretty low, no matter the type of loan, since you pay it off in only 5 years. - the effect of a very rapid increase in interest rates is not reflected well because you are paying off the principle so quickly - the total interest paid is actually higher than it would be, since a normal payment plan would have you making principle payments monthly
Five scenarios based on a $10K loan. 1. You get a private loan at prime (3.75) and it never goes up (v. unlikely) 2. You get a Grad Plus at a fixed 8.5% rate. 3. You get a private loan at prime (3.75) and it goes up 100 bps each year. This is reasonable since prime was 5.00 last year. 4. You get a private loan at prime (3.75) and it goes up 200 bps each year. Not unreasonable in the current economic climate. 5. You get a private loan at prime (3.75) and it goes up 300 bps each year. Probably a worst case scenario.
I was originally having a hard deciding between the Grad PLUS and the alternative loan but after having giving a couple of lenders my credit score (766) I found out that the alternative loan isn't as attractive. I thought that I would be able to qualify for the better rates, i.e. Prime + 1%, however my score puts me in the Prime +5%. That by itself is already as much as the Grad plus rate and it would most likely go up. They told me that one would need a fico score of around 820 in order to get near the Prime +1% rate.
Also, I called my loan provider because I hadn't heard anything back after applying and she said they are waiting for my school to certify the loan. She said a lot of school are waiting until July because the gov't will be setting the new interest rates early that month.
Maybe we'll luck out and see the 8.5% Grad plus drop a bit?
One other thing to note this week is the big change in the Eurodollar futures contracts, which is tied to LIBOR expectations. For instance, from Wednesday to today, Eurodollar contracts scheduled for December 2010 delivery fell 50 bps, which implies expectations for future LIBOR rose 50 bps in just 3 days. With movements like that it wouldn't take much for variable (i.e. private) student loan rates to rise higher than fixed rate student loans.
Another thing to consider is taking out loans against your 401k. I think you can typically borrow against half of your balance, so it may or may not cover all your tuition (but every little bit helps). Looking at mine, the rate was 3.25%, so it's definitely something to think about. The catch is that the payback period is shorter term (3-58 months). Anyway, just something to consider. _________________
Another small (slightly morbid) item to note in comparing federal vs. private loans is that the federal loan balances are forgiven if the borrower dies. Private loans would go against your estate and could create a financial liability for your survivors.
Does anyone have an idea what credit score it takes to qualify for the best rates from private lenders? I was surprised to find out that I "qualified" for the worst rate 7.75 + LIBOR from Discover Financial. My credit score is in the 80th percentile.
That's not entirely surprising. First, it's an unsecured loan so banks are going to save the best rates for people with sterling credit scores (but of course they'll advertise the heck out of those rates). Second, the govt did away with subsidies for private education lenders, so of course banks will raise rates to compensate for the lost subsidies. _________________
There are two downsides to borrowing against your 401k
1) No grace period 2) Returns are limited since a good portion is tied up in your loan.
The benefits are good though: 1) Low fixed rate (4.25% at my company) 2) Flexible payment options (1-10 years usually) 3) The interest you pay goes to YOURSELF (or specifically your 401k)
I don't think you can borrow if you quit. At least for my company any loans on your 401K needs to be repaid immediately upon termination of employoment. Otherwise it will be considered a withdrawl and taxed/penalized accordingly. _________________