Why Co-signing a Loan is the Best Way to Help Your Kids Borrow for College

I know, you love your child and want the best college for them.  They worked so hard but are a little – or a lot – short of affording their dream school.  Don’t fall into the parent trap of borrowing heavily for college at the expense of your retirement.  You can help them without hurting yourself.  Here’s how to find the middle ground.

Start by framing the discussion like this: college loans should be the last resort, not the first option.  First, look to savings to reduce future debt.  Even if you start late in high school, it’s ok because bills will continue to arrive four or more years down the road. Saving a dollar today beats borrowing one tomorrow. Here’s an article on college affordability and a podcast.

Next, look for free money: gifts from relatives, grants and scholarships that do not have to be repaid.  Here’s an overview of need vs. merit based aid, and a drill-down on grants.

Finally, determine if you or the student can contribute earnings while the student is in-school racking up those bills.   When savings plus free money plus current income exceeds the cost, no loans are necessary.   Be sure to account for all four (or more) years the student will be a college student, if there is a gap between expected cost and available resources, then it’s time to consider loans.  For most students, the Federal Loan program is by far the best option when you consider the interest rate and repayment terms.  One problem: the amount that can be borrowed is capped.

Let’s assume that the student takes a government loan but a gap still remains between the cost of college and the sources of money. Now all eyes turn to you (or perhaps grandparents or other relatives) for help.

The BEST ADVICE:

  • Co-sign a loan and make sure it has a co-signer release. Many private loans now have a feature to permit you to be dropped from the loan once your child establishes their own good credit.   With this type of college borrowing, you effectively lend your established credit profile to your child so they can be approved for a loan at a time they would not qualify on their own.   Once a good repayment record on the loan is established, the student should contact the loan provider to release you, the co-signer, from future obligations to pay.  Co-signer release is a terrific feature because it permits you to help your child borrow when they need your help. And for you to be released from that obligation when they get on their financial feet.

If there’s no way around it and you have to be the designated borrower, you should:

  1. Shop around. Many parents with good credit can receive substantially lower interest rates on private loans from banks, finance companies or state agencies than the Federal PLUS program.
  2. Be VERY wary of the Federal PLUS Loan. Parents with marginal or bad credit may be eligible for a Federal PLUS loan, but be wary.  The credit analysis used to approve a PLUS loan is minimal and the amount that can be borrowed is very high (the full cost of attendance).  Sounds good?  It’s not.  It is a toxic stew. The government regularly makes large loans to people who will be unable to make the payments.  This is a ticking time bomb waiting to explode.   Also, some parents falsely surmise that they will transfer their PLUS loan to the student in the future.  That is not possible under the terms of the PLUS loan. It is a Parent loan, not a student loan.
  3. NOT borrow from your retirement accounts to pay for your child’s college. It sure sounds good to “repay yourself” the interest that accrues on a loan rather than paying a bank, but it is a terrible idea. Why?  Every dollar you withdraw from your retirement account is one less that can earn interest, dividends or appreciate to grow your retirement savings – and at a time when your retirement is fast approaching.  Just as young families are instructed to start saving early to benefit from compounding, older savers should avoid touching the nest egg because you (we) are running out of time to grow the account. This is no time to stretch.

If you’re a data hound and seek some data about parent (and grandparent) borrowing, check out the Consumer Finance Protection Bureau’s recently released “Snapshot of Older Consumers and Student Loan Debt.”

Like many data analysis, this one can be used to support both sides of an argument.   Here, (a) older (age 60+) borrowers are under stress and (b) older borrowers are doing ok.     The CFPB report compares the 10 year period 2005-2015.  The data in parenthesis is 2005 data as cited in the report:

Older borrowers are under stress:

  • Consumers age 60+ is fastest growing segment of the student loan market
    • They owe $66.7 billion
    • There are 2.8 million older borrowers, (up from 700,000)
    • They owe on average $23,500, (up from $12,100)
  • Delinquencies are up from 7.4% (2005) to 12.5% (2015)
    • 37% of borrowers over 64 are in default
    • 40,000 have Social Security benefits offset (8,700 in 2005)

Older borrowers are doing ok:

  • 73% is borrowed for children or grandchildren – indicating a choice to help rather than being burdened by their own debt.
  • Fewer than 31% of older borrowers owed federal loans (867,000 of 2.8 million)
    • Fewer than 7.5% held PLUS Loans (210,000 holders)
  • Of 2.8 million borrowers, only 1,100 lodged loan complaints with the CFPB

What does this all mean?

To me, it’s clear.

  1. Parents should establish a college savings program for their family that is appropriate for their financial situation.
  2. Students should seek financial aid by filing the required forms.
  3. Parents and students should realistically assess how much current income each can contribute to defray costs while the student is in school.
  4. Students should be primarily responsible for taking loans for college. The federal loan program is the best solution for most of them.
  5. If parents are enlisted to help their students with loans, they should contribute by co-signing a loan with a co-signer release.
  6. If parents need to be the sole obligor to borrower for their child’s education, they should shop around, be wary of the federal PLUS program and not borrow from their retirement account.

I can’t help but think of the airline oxygen mask analogy.   There is a reason we’re instructed to put on our oxygen mask before taking care of a child.   Incapacitated parents are of no help to kids.  The same is true for parent borrowing for college.  If you feel compelled to help borrower for a child or grandchild’s education, be sure not to imperil your future well-being.  Co-signing a loan helps the next generation achieve their dream of a college education without imperiling your dream of comfortable twilight years.

Paying for college with early admissions

Have you looked into getting admitted to a preferred school much earlier than standard admissions deadlines?  Then you’re probably considering an “early decision” or “early action” where the student chooses to attend a specific college much earlier than standard admissions deadlines.

early-bird
Early Bird admissions and financial aid

Know the difference: Early decision (ED) refers to a binding decision to attend a specific school.  Students taking early decision commit to one specific school as early as the fall semester of senior year, foregoing admission to any other institution.  Early Action (EA) is a non-binding admissions process where students are notified very early of their acceptance but may choose to attend a different school.

Early decision: How’s it paid for? Going forward with an early decision requires organization and a clear path to covering the balance.  Traditionally, the biggest challenge associated with early decision was affordability, since the choice was made without comparing actual financial aid offers from other schools.  Gaining early admission with the means to pay the bill outright regardless of financial aid and scholarships works for some, but not all families. If the financial aid offered with an early decision application is too low, families have the option to appeal the decision and ultimately reject if proven unaffordable.  Going through early decision only to end up not attending is an avoidable stress through realistic college planning, so unless the school is an absolute “must attend” situation, it may not be worth applying this way.  It’s expected that students only submit one early decision application to one school, but may also submit standard applications to other schools by agreeing to withdraw those applications if accepted for the early decision school.  There is a wide gap from early admissions beginning in November to when standard admissions deposits are due in May, so be aware of deadlines to know when a final decision is required.

Early action: What are my options? Early action admissions allow students the benefit of immediately applying to several schools instead of just one.  This allows for families to compare financial aid offers without being bound to just one institution. Early action has become much more common to help students zero in on their final college choice after recognizing all their best options. Early action does require a pro-active approach to make sure each school has all admissions and financial aid information available allowing for clear comparisons between offers.

Financial aid applications are early too: The FAFSA (and CSS Profile) has been available since October 1, 2016 for college students beginning their freshman year in Fall 2017.  This is 3 months earlier than the traditional January 1st FAFSA date, allowing more time for schools to begin sorting through many financial aid requests and early admission applications.  Since this is the first time FAFSA is being made available so early, most schools are still following  regular deadlines like in March, April and May.  But for families handling early admissions, this earlier date hopefully provides more breathing room to compare options.

Merit based vs need based funding: Remember the differences between college funding. Grants are need based financial aid awards provided by federal, state and school programs considering  income and asset information on the FAFSA and/or CSS Profile.  Merit based scholarships are awarded to students considering high test scores, grades, sports, community service and other student qualities and achievements.  When making a final choice about early admissions, make sure the financial aid award letter accounts for both need based and merit based funding eligibility.  You want a complete financial picture when comparing school options, which is why all your financial aid documentation needs to be filed as early as possible.

 

Three Simple Ideas to Start Fixing the Student Loan Mess

I’m back from a few days in Washington, DC.   Despite working on Capitol Hill for two years, I’m still struck by the disconnect that seems to exist between our real world and their political world.   These ecosystems need to collide if we’re going to seriously begin addressing the real world student loan debt crisis.  Here are three simple ideas that would help borrowers immediately and could be the basis for a long-term solution to the spiraling college debt problem:

  • Stop categorizing federal loans as “aid” on Financial Aid Award Letters
  • Stop charging students and parents origination fees to obtain federal loans
  • Start requiring the Direct Loan Program to report Annual Percentage Rate (APR) calculations

We know the statistics: there is $1.3 trillion of student loan debt outstanding. We’ve heard the sound bites: college loans hamstring graduates who have taken on piles of debt and are underemployed.  So what’s the answer? Previously I’ve offered my thoughts about college affordability and ways for students to avoid excessive debt. However, there are some factors that are simply out of their control and need to be fixed in Washington. And soon.

In the political world, current efforts are largely focused on relieving over-leveraged borrowers of repayment stress with loan forgiveness programs and income-based repayment plans. Great, but these programs address the problem after it has occurred and leave the root causes untouched.   We need to fix the problem at the source. In this case, before a loan is made.

Transparency and disclosure are all the rage – and rightfully so. But, the federal government comes up woefully short in providing adequate disclosure in two critical areas for the Direct Loan Program:

  • Marketing loans via colleges
  • The total cost to borrowers

Did you know that the federal government:

  1. Permits colleges to categorize federal student loans as “aid” on Financial Aid Award Letters.
  2. Charges borrowers fees but does not disclose an Annual Percentage Rate (APR) for their loan?

In effect, the largest student loan lender — with over a 90% market share — permits itself to market student loans as financial aid through colleges and universities without disclosing the APR. I bet the Consumer Financial Protection Bureau would have a field day with a private lender engaged in these business practices.

Loans as “Aid”

Remember the old story of the wolf in sheep’s clothing? I do whenever I think about a high school senior first encountering a student loan “awarded” via the financial aid process.   Or worse, a parent relieved that their child’s dream college is within reach because they’ve been “awarded” a PLUS loan. A PLUS loan is packaged as “aid” but it comes with big up-front fees and encourages parents to borrow up to the full cost of attendance as long as they don’t have adverse credit — a very low level of scrutiny. Intentional or not, the disingenuous miscategorization of loans as aid no doubt confuses borrowers and leads to some very bad decisions regarding college affordability.

APR not required for a lender with a 91% market share 

According to the College Board, for Academic Year 2013-14, approximately $113 billion of student loans were made. Approximately $9.7 billion of these loans were made by non-federal lenders, mostly banks, credit unions, finance companies and some state based entities.   Few, if any, charge fees to originate the loans, and all are carefully watched to ensure consumers are treated fairly and receive proper disclosures including APR calculations.

Then we have the other lender, the federal government, which made more than $103 billion in student loans.   This monopolistic market share resulted from a long political struggle to replace private lenders participating in the government’s guaranteed student loan program with a nationalized student loan program under the auspices of the Department of Education.

No matter your opinion of the Direct Loan Program, can anyone make an argument to justify:

  1. Why government charges fees to obtain loans when private lenders do not?
  2. Why the Department of Education is not required to disclose an APR?

The Good News – Thanks to the DoE

Kudos to the Department of Education for recognizing the first problem addressed here – student loans nicely wrapped in the sheep’s clothing of a Financial Aid Award Letter.   Beginning in Academic Year 2013-14, the DoE introduced its Federal Aid Shopping Sheet, which asks colleges to CLEARLY show the:

  • Cost of attending the college
  • Amount of grants and scholarships awarded to the student
  • Net Price that the family will pay.

The standardized form then delineates what options the family has to pay those net costs:

  • Work options
  • Federal loan options
  • Other options including non-federal loans

Thousands of colleges have agreed to use the Federal Aid Shopping Sheet but thousands do not. Some likely add to the confusion by providing students with both the institution’s Financial Aid Award Letter and the Federal Aid Shopping Sheet.

Here’s a federal regulation I would support: require all Title IV eligible colleges to use the same form of a Financial Aid Award Letter with simple and clear disclosures so families can easily compare the cost, aid packages and options for filling the gap.   Don’t re-invent the wheel: the Shopping Sheet seems to fit the bill very nicely.

A Final Thought

To end where I started: our political leaders, no matter how well intentioned, seem stuck on a very unproductive treadmill of churning out sound bites about the student loan mess.   They’re spending too much political capital addressing the symptoms of the problem rather than actually fixing it at the root.  It’s time to replace political sound bites with real world actions to help families avoid excessive student debt.  My suggestions:

  1. Require all Title IV eligible schools to use the Federal Student Aid Shopping Sheet
  2. Stop charging students and parents fees to obtain federal loans – the private student lenders do not charge fees
  3. Provide APRs to federal borrowers

What do you think?

 

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John Hupalo is the Founder of Invite Education and co-author of the recently released book: Plan and Finance Your Family’s College Dreams: A Parent’s Step-by-Step Guide from Pre-K to Senior Year

October 1 FAFSA: Getting ahead on college funding

For the first time, the FAFSA will be available beginning October 1.  This is a big move from the traditional January 1st date for FAFSA availability, and will change the timeline for financial aid processing with implications for admissions.  If you’re planning college admissions in Fall 2017, it’s already time to get started!

Prior-Prior Year Taxes (PPY): A move that will help streamline the process is the use of Prior-Prior Year Taxes to complete family financial information on the FAFSA. The 2017-2018 FAFSA will require info from the 2015 year tax returns.  Those returns have long since been completed by most families, and may be available for digital transfer from the IRS via their Data Retrieval Tool.  This means the financial details of your tax return can automatically populate the FAFSA, saving you time from data entry.  Also, using Prior-Prior Year taxes negates the need to make estimations on the FAFSA when tax returns were incomplete.  In the past, when FAFSA filers were required to use only the Prior year tax returns, they were encouraged to file the FAFSA on January 1st, before their actual tax returns were completed.  Now that tax returns from the Prior-Prior year are used, there’s no need to estimate.

Expect similar admissions deadlines: Most colleges are maintaining their same admissions deadlines. May 1 will still be the major deadline for enrollment decisions.  Early Decisions will be the exception from school to school.  The big impact early FAFSA makes is that there will be more time for schools to process new incoming financial information, and families can get a better idea of their financial aid eligibility earlier in the process.

Pay attention to institutional funding deadlines:  Institutional funding is money reserved by the college and awarded based on their own internal criteria and methodology.  Eligibility requirements and deadlines can vary from school to school.  Make sure to identify any deadlines for institutional funding to stay ahead of the curve. The simplest way to achieve this is by making sure all financial aid forms are completed and submitted in advance of any deadlines.

Remember the CSS profile:  The FAFSA obviously gets a lot of attention, but the CSS / Financial Aid Profile is also required for about 400 select colleges when applying for financial aid.  It goes more in depth than the FAFSA and is also available beginning October 1.

Dealing with uncertainty on the state level: Many states provide need based grant programs to students with low income based on data provided on the FAFSA.  While the federal FAFSA is available beginning October 1, not every state will have their grant budgets for the 2017-2018 years ready yet.  Be aware of any financial aid awards relying on estimates for state based funding as they may be subject to change based on final state budget legislature.

How do I save for retirement AND college?

Finding balance between retirement savings and college savings represents a challenge most families need help managing. If you feel overwhelmed, you’re not alone. Consider some eye-opening statistics from Roger Michaud’s recent article “Financing Education is a Retirement Issue “

  • When it comes to financing a college education, 21% of parents would delay their retirement and 23% would withdraw money from their retirement account to help fund college
  • 94% of parents believe college savings will impact their ability to save for retirement
  • 56% of parents with children in the home are currently saving for retirement

The struggle is real, especially when parents would actually withdraw from their retirement savings to help fund college. Early withdrawals face taxes plus potentially a 10% early withdrawal penalty making it less of a financial plan and more of a knee-jerk reaction.

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Find Your Balance

Why? Let’s consider the circumstances. Retirement is most often cited as a goal for long-term savings, but the rise in college costs has emerged as a financial challenge as well. Retirement planning extends beyond the typical 18 years leading up to college attendance, and parents may have started saving for retirement before they got married and had kids, giving them a head-start. This creates a false sense of security where a parent may simply feel comfortable pulling money for retirement to help fund their child’s college dreams, but this is unsustainable. Here’s how families successfully manage both.

Start with retirement savings: Securing your long-term financial goals puts you in best position to help your children over time without unnecessary financial sacrifice. Every dollar counts, and the tax benefits provided by Traditional and Roth IRA’s, 401(k) and 403(b) really help long term savers. While you cannot predict the future of your child’s academic plans, you do know and understand your own future financial needs better than anyone else. Once you’ve mastered your retirement plan you can more confidently pivot the remaining income towards college savings.

Play the long game with college savings: Take a big picture perspective, developing your patience and putting value on consistency. This is a relaxing exercise far removed from an overly busy day-to-day life, so enjoy it and you’ll thank yourself many years down the road. Stay motivated by reviewing savings progress as consistently as you would review your child’s report cards every semester / quarter. You’ll notice that as the savings grow, your child’s academic progress will help you zero in on admissions criteria for various colleges, further motivating you to stay the course. Maintain active engagement by using simple online tools like Invite Education’s Passport for Success that outlines college savings and academic planning all on one platform.

Enfranchise your child: Help your child develop their role as an active saver for college. During the key early years, its expected parents and perhaps relatives will make the lion’s share of deposits in college savings accounts. Once the child begins some part time work, have a portion of those earnings added to the college savings account to help them get involved. This helps develop an all-important habit of saving, a key lesson often overlooked but sorely needed for financial literacy education.

Forecast Financial Aid: Savings are accounted for as part of financial aid eligibility calculations, but the way the money is saved makes an impact. For example, cash in a checking account in the student’s name can weigh against financial aid eligibility by as much as 20% of full value on the Free Application for Federal Student Aid! There’s a better way. If you’re worried about financial aid eligibility, just remember;

  • It’s cheaper to save long term than to borrow and pay back loans later
  • On the FAFSA (Free Application for Federal Student Aid) money saved in a 529 plan owned by the parent is weighed against financial aid eligibility at 5.64% of full value, a great reduction from cash found in a checking account.

In other words, college savers are not punished for their efforts. It’s the income from work declared on the FAFSA that can reduce financial aid eligibility more dramatically. Always use a financial aid estimator to forecast and plan ahead, but you may quickly determine that your income would remove eligibility for Pell or State based grants. This reinforces the need for college savings with an early start date to allow greater time to compound, putting your family in better position to handle college expenses as they arrive. This is especially important for families considered “middle class” as they may have just enough income to reduce financial aid eligibility, but lack the actual cash to pay college outright. A dedicated college savings strategy is critical in such cases.

Top 5 reasons for 529

April is #FinancialLiteracyMonth offering many reminders about the importance of saving. Thinking about starting a 529? Here’s 5 reasons why the 529 makes an excellent option.

1. It’s cheaper to save than to borrow:  It’s much more than “a dollar saved is a dollar earned” today, as many utilize student loans to cover the rising cost of higher education.  Having to borrow becomes a much more costly endeavor long term, where savings is a more attractive option.  For example, saving $100 per month averaging 4% rate of return compounded annually over 18 years would produce about $31,437.  If borrowing $31,437 at 4%, a 10-year repayment schedule would require monthly payments of $318.28 for a total of $38,194.24 repaid.  The $6,757.24 in interest costs may be a tax deduction in future years of repayment, but it’s clear that a little bit of early savings goes a long way to cover college costs.

2. No income limitations: Regardless of how low or high family income is, there are no income limitations associated with the 529 plan.  This is unlike the Roth IRA, a retirement savings program that is only available for single people making less than $116,000 per year or married couples earning less than $183,000 per year as of 2015.  Savers make saving a financial priority and are not limited by the 529 because of future gains on income.

3. Tax-free growth: Quite simply, 529’s offer a tremendous benefit of tax free growth.  Specifically, all earnings grow free from federal taxes.  Most states conform to the federal tax free treatment with 33 offering state tax deductions

4. Best savings option when considering financial aid: Families concerned their savings may affect their eligibility for need-based financial aid should take a look at the 529.  Ultimately, the way cash is saved is what’s most important. On the FAFSA (Free Application for Federal Student Aid) money saved in a 529 plan owned by the parent is weighed against financial aid eligibility at 5.64%. For example, $10,000 saved in a 529 could end up reducing financial aid eligibility by $564.  However, this is much better than having money in a standard savings account in the student’s name, where it can be weighed against financial aid eligibility by 20%. The 529 provides a superior vehicle for college savings given financial aid regulations for higher education.

5. Great for estate planning: Grandparents are finding creative ways to help fund college for their grandkids while retaining control of their assets as part of their estate.  Money put into a 529 is removed from the taxable estate, but grandparents are able to retain rights of control over the 529 account even when funding is typically used to cover future college expenses for their grandchildren.   Generally, the goal of estate planning is to reduce tax liabilities and provide assets to family members as efficiently as possible.  Under current tax law, you are permitted to gift up to $14,000 per year to another person for any reason without having to pay a gift tax or a generation-skipping tax (GST). This limit is sometimes referred to as the “annual exclusion amount.” With a 529 Plan, however, you are able to make a lump-sum contribution equal to five years of annual exclusion gifts to a beneficiary in a single year. This means that you can give up to $70,000 (if you are single) or $140,000 (as a married couple) at once, per beneficiary, without having to pay gift or estate taxes.

Learn more about Invite Education’s 529 search engine and college savings calculator, helping your institution provide families with savings strategies and grade-by-grade guidance every step of the way.

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