How the October Sequester Will Impact Grad PLUS Student Loans (and Why You Should Care)

The term “sequester” may seem so 2013, but the truth is that these automatic spending cuts are still in play – and the next round is scheduled for October 1^st.  Whether you’re currently financing an MBA or other grad school program with Direct PLUS loans or you’re considering using them in the future, these new sequester cuts may have an impact on the amount of money you’ll end up spending on your loans.

So what exactly do you need to know about student loans and the sequester?  Here’s the scoop:

Remind me again – what’s the current state of the sequester?
The Budget Control Act of 2011 (BCA) created the sequestration we’re experiencing today.  BCA raised the debt ceiling while also establishing a “super committee” of bipartisan politicians tasked with reducing the deficit by more than $1 trillion over the following decade.  When they couldn’t come to an agreement about how to do that, the sequester went info effect – effectively making the decisions for them.  As a result, we can expect yearly budget cuts on things like defense spending, Medicare and other government programs (including federal student aid) through 2021.

Okay, so what does this have to do with my Grad PLUS loans?
Over the past couple of years, the sequester has triggered a few small increases in the loan fee (also called an origination fee) paid by borrowers of Direct loans.  For Direct PLUS loans, the fee went from 4% for loans disbursed before June 30^th, 2013, to 4.204% for loans disbursed between July 2013 and November 2013, to 4.288% for loans disbursed between December 2013 and September 2014.  PLUS loans disbursed after October 1^st will see that fee rise once again, to 4.292%.

What is this “loan fee”, and why am I paying it?
In addition to charging interest on your student loan, most federal loans and many private lenders also charge an upfront fee for originating, or making, the loan.  The fee is a percentage of the total amount borrowed, and is deducted proportionately from each disbursement you receive.  Essentially, even though you’ll never see the money, you’re still on the hook for repaying it.

But the October fee increase seems very small – why should I care about this?
The Direct loan fee increase caused by October’s sequester cuts is tiny, so if you’re worried about spending a lot more on your Grad PLUS loans this year versus last year, don’t be.

However, this latest fee increase is an important reminder that when you’re comparing loan options, it’s crucial to look at all the factors that might affect your financial bottom line.  Direct PLUS loans have historically been a popular way for MBA candidates and other grad students to finance school, since you can borrow as much as you need to, up to the cost of attendance determined by your school for your program.  But between rising loan fees and the recent PLUS loan interest rate increase (from 6.41% to 7.21% for loans disbursed after July 1^st), some graduate borrowers may actually save money by going with a private loan.

Don’t private loans charge fees, too?
Many do, but some don’t.  And those fees can vary, so it’s helpful to shop around.  SoFi, for example, charges no origination fee on most of its loan products.

In addition to comparing fees on federal vs. private loan options, it’s important to remember that Grad PLUS loans offer one rate for all borrowers, whereas private lenders will give you a rate based on your creditworthiness (determined by your credit score and other relevant financial information).  Since many grad students are “mature” borrowers – meaning they’ve had a few years to build up their credit – they have a better chance of qualifying for a relatively low interest rate with a private lender like SoFi (SoFi currently offers in-school loans for certain MBA programs – check out our low MBA Loan interest rates here).

What are the other considerations for choosing between a federal and private loan?
Besides comparing the cost of borrowing, you should also consider the benefits that come with Grad PLUS loans that are not available for private loans.  For example, some federal loans offer the possibility of income-driven repayment options, such as Pay As You Earn (PAYE).  This program allows borrowers with financial hardships to make lower payments and potentially even have the remainder of their principal forgiven after a period of 20 years (10 years, if you work in public service).  If you think you might need one of these options, you may be better off going with a Grad PLUS loan than a private loan – you can always refinance your loans at a lower rate a few years after graduation, when your financial situation is more secure.

But many MBA and other grad students know that they’ll never benefit from these programs because of their high income potential.  If you feel confident about your future income and your priority is saving money, you might be better served with a lower interest rate private loan like the SoFi MBA Loan.

So what’s the takeaway?
The student loan world is constantly evolving, and it’s tough to keep up with all the changes that may impact your loans (not to mention your bank account).  The best thing you can do is take the time to compare different loan options and work with your grad program’s financial aid office – they should have the latest information and be able to help you make the decision that’s right for you.

This article does not purport to provide legal or tax advice.  It is meant to provide general information of interest to readers who have student loans.