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Student Loan Interest

Written by: Tony Robinson

As a parent or student, the need to be informed about the benefits of student loans, the extremely low interest rates, and the tax benefit they provide has increased tremendously over the last few years as education costs have risen, and the need for every deduction and credit has also increased. The Internal Revenue Service and the US government have now included student loan interest as a tax deductible item on the personal tax return. The second, and perhaps most important reason, is due to the fact that interest rates on student loans are beginning to climb, several percentage points. As of August 1, 2005, the previous cap on the maximum student loan interest rate was repealed, and the new rates went into effect; what is the effect on existing student loans? What will the effect be on new student loans? How does this affect the bottom line of the students or parents tax return? These are questions that parents and students alike are seeking the answers to, prior to the rate change. Many of the organizations that offer student loan consolidation programs urged students to consolidate existing loans in order to lock in the low interest rate, while still available, as the new rates would definitely impact tax returns as the student begins to repay the loan, or the parent repays the loan.

Interest rates on federally subsidized loans do not have the tremendous impact on a student's finances when compared to unsubsidized or private issue loans. Deferred payment loans that also defer interest payments can generate extremely large additional amounts of debt for a student borrower because the loan is accruing interest on interest charges. Now, can you see how a change in interest rates would have a huge affect on student loans and student taxes?

In order to promote the advancement of continued education, the government has, over the last several years allowed the interest paid on student loans be a deduction on your tax return. This has helped ease some of the expense of college, but it isn't a direct form of relief. The individual claiming the deduction simply gets a portion of the interest deducted on their itemized schedule of deductions; it's not a dollar for dollar credit.

Deferred payment loans originally existed to create a buffer for the student borrower trying to attend school and work enough to keep up daily needs. Deferred payment allows the students to borrow, attend school without the worry of monthly loan payments, and then assume the responsibility for monthly payments upon completion of their degree. The government offers deferred payment loans to students in two forms, subsidized and unsubsidized. The subsidized loans are for students with a demonstrated financial need; the government pays the interest accrued until the student has finished or left school. Unsubsidized loans are not need based; the student is responsible for interest as it accrues on the loan. Either way, the interest is taken care of and paid monthly.

There are lenders today, who offer deferred payment loans simply because of the income they generate for the institution extending the loan. Students, who do not pay interest as it accrues, will pay interest charged on their interest balance each month. Many reputable lenders see this as an exploitation of the student, and do not even offer such a product. Private loan products offered through lending institutions, where there are no federal lending requirements associated with this particular loan product and the student's school status in relation to financial need, have made a business of deferred payment loans. These very profitable loan products are often offered to students, who do not realize or necessarily understand the concept of the interest charge incurred on interest accrued.

Deferred payment loan products offered within the boundaries of the federally subsidized or unsubsidized guidelines are tremendously helpful to students and parents during these lean years of college funding; some of the private loan products, however, merely take advantage of the financial needs of student borrowers. Read carefully the terms and conditions of your loan and if offered the opportunity, make interest payments as the interest accrues. Your student loan debt at the end of the deferment period will be much smaller if the interest due each month has not been added to the amount due each month. In this way, you are only making interest payments, which are easily affordable, and you get to deduct the interest each year from your tax return.

About the author:

Tony Robinson is a Webmaster and International Author. Visit http://www.tax-portal.com/ for his tax tips.


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