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

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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.

John’s Jots #3: Helping H.S. Seniors Pick Their College

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Hooray — Finally.  For the first time that they can remember,  most high school seniors (and their families) now have the power in the college selection process.  With college  acceptances having been received and the May deposit deadline looming, the shoe is on the other foot.   Applicants have morphed into accepted students and most colleges are now the ones sweating.  What will their yield numbers and net tuition dollars look like once the Class of 2020 forms?   Seniors are very close to the end of a long journey.  However, as Yogi Berra said: “it ain’t over till it’s over.”  And it ain’t over yet.

Here’s what high school seniors and their families should consider:

  • Which college is the best academic and social fit?  To get to this point, the college made some favorable impression but now it’s time to dig in a little deeper.  This is the time for a revisit, discussion with a current student or a little more research into majors offered, internship opportunities, job placement rates, social activities — is greek life important? — and other areas of student interest.  Can the student visualize her/himself on the campus?
  • Which college is most affordable?  For some, this may be the first and most important question.   No more theory about paying for college, it’s nut cutting time.  In the summer, a tuition bill will arrive.  For some with lots of merit and need based aid, the bill may be small or zero.  For most, the cost of attendance less free money (grants, scholarships and gifts) may leave a gap that needs to be filled.  Take that gap amount and reduce it by the amount of savings that can be used for the first year and any other gifts or projected income to be kicked-in.  Parents may allocate some earnings, while students may contribute from a work-study or a part-time job.  Now that all of the free and earned  money had been exhausted, the college with the smallest remaining gap is arguably the most affordable.   If a gap still exists, you will likely need to borrow from  the federal government or a private credit student loan lender.  Here are a few important tips when it comes to borrowing student loans:
    • Borrow as little as possible.  Whatever is borrowed needs to be repaid with interest.  And remember, college may last 4 or more years.  Think seriously about how much will likely need to be borrowed over the course of the entire college experience, not just the first year.
    • Pick a loan that makes the most sense for your situation.  The federal Direct Loan program is most often, not always, the very best for student borrowers.  There are up-front fees but the interest rates are relatively low and for lower-income borrowers, the government pay the interest while the student is in school.  After graduation — when it’s time to begin repaying the loans, all federal borrowers are eligible for repayment plans that are more favorable than private credit loan plans.  There are also parent loans available from the federal government (PLUS Loans) and from private credit lenders such as banks, credit unions, finance companies, and some colleges and state agencies.
    • Figure out your monthly payment NOW — before you take the loan.  How much will the required monthly payment be once it’s time to start paying?   Repayment usually begins six months after separating, i.e. graduating or leaving the college early.  Does the projected monthly payment (most loans require minimum monthly payment of $50) make sense based on what the  monthly earnings might be?  The Bureau of Labor Statistics and others offer earnings statistics by job and sometimes by major. Look them up.  One rule of thumb is that college loans should not be more than 15-20% of income.   And remember — there may be need to borrow for more than one year.  DO NOT PUT YOUR HEAD IN THE SAND AND THINK THAT EVERYTHING HAS TO WORK OUT FAVORABLY.  BE REALISTIC.  WILL THE POST-GRADUATION JOB PRODUCE ENOUGH INCOME TO PAY-OFF THE DEBT?  No one starts out with the goals of becoming the next headline of the poor student who took a ton of debt and wound up with a low paying job.

The pot of gold at the end of the rainbow looks like this: a student graduates from college in 4 years having enjoyed a great campus experience with a job offer in hand and manageable debt that will enhance their credit rating as they make repayment.  For a nation that put a man on the moon in less than decade after President Kennedy’s inspiring call to action, the goal of college graduates without mountains of debt does not seem to be much of a reach.

High school seniors should enjoy these heady days of having the power on their side but should use them wisely to set the stage for great success in college.  The decision high school students and families make in the next 20 days may well determine if the promise of their college dreams become reality.  Those who pick an affordable college that offers the best academic and social fit will be on the road to success.

 

 

Top 5 reasons for 529

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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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