adjustable or fixed rate student loan

Hi Terry,
Our oldest child is going to be a sophomore in college. He attends a highly-selective school and received a generous grant. Last year he also received three outside scholarships totaling and additional $8,000. Only $5,000 was a renewable scholarship. We used up about 10,000 of the 13,000 that was in his 529 plan to come up with the balance. This year we will have to take out a loan for about 10,000. We are having trouble deciding what loan to use. The university offers a parent loan at 4.5%, but it adjusts each year, and you have to start making payments right away. We are also looking at Discover Student loans, which can be either adjustable or fixed, based on different scenarios. At this point, we were hoping to pay no more than $50/mo if we have to start paying now. What are your thoughts on adjustable rate student loans, is it too dangerous…or possibly a good thing?

Terry Says:  You have a very tough choice.  The current fixed rate loans are way too high — far higher than a mortgage.  But the adjustable rate loans expose you to upside issues if inflation returns.  (Given all the money printing around the world, that’s a fair bet to happen sometime in the future.)  And there’s a price to pay for uncertainty of future payments with an adjustable rate loan.

And one more thing:  You say this is your “oldest” child — which implies you will face this problem again with another child!

I truly hate to see parents get on the hook for these huge payments, or raid their home equity or retirement funds.  In fact, I have always advised against going to that expensive prestigious school, in favor of a community college or state school, at least for the first two years.  It’s a bit late to give that advice now, and your next child is going to want the same treatment as his/her older brother!

You need to sit down with a financial planner and make a plan for these ongoing expenditures.  Because you will face this same situation for another three years.  At some point, you may have to tell your son you simply can’t afford it!  Having a planner work with you will let you know the total impact.

Specifically, I’m not sure — and suggest you ask — about two issues with a parental loan.  First, how is it reset (based on what?) and how frequently is it reset, and is there a “cap” on how high the rate would go — and what would be the monthly payment if it goes that high?   And second, if  rates do stay low — or even go lower — can you ever renegotiate the loan, and is there a penalty if you decide to pay it off early if rates go up?

Those are the most important considerations — but truly you need to look at the BIG picture on this — the total amount of debt, and payments, you will be taking on for all your children — and how it will impact your own future financial security.