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.

3 Tips for Smart Student Borrowing

When it comes to paying for college, the process can seem overwhelming. There are so many financing options out there and you might be feeling lost about how to choose the correct ones for your family. The key is to equip yourself with information so that you can have knowledge you need to make an informed decision.

One of the most common ways to pay for college is student loans. There are two primary sources of student loan funding: federal loans and private credit loans. The two programs differ in fundamental ways: the money for federal loans comes from the Department of Education whereas private loans come from places like banks, credit unions and other financial institutions.  Federal loans are much more standardized providing the same rates and fees to all borrowers. Most students tend to take advantage of federal loans before moving onto private loans if they still need extra money.

For some families, private loans are a good option because offer competitive rates and a cosigner option to help student-borrowers gain approval. Other families will choose federal loans, which can be easier to get and offer flexible repayment options, like income-based repayment.  Whichever type of loan you choose (and some families take out both private and federal loans), there are a few ways to borrow smart.

Don’t borrow more than you need. Many families get caught up in the availability of what may seem like free money and end up taking out a bigger loan than they need, just because the option is there. But a loan is not free money, even though it is labeled as “financial aid” on a student’s award letter. Every cent you borrow has to be paid back in the future, and often with interest, which can sometimes be up to a few thousand dollars on top of the loan principal. Don’t take out too much money from a student loan; it should be used for education costs only. Take a careful look at actual expenses and remember that interest will accrue on the total balance. You can use a Student Loan Payment Amount Estimator to get an idea of what your payments might look like once you’ve graduated. Be smart about the debt you’re taking on. Only borrow the amount you actually need, otherwise you could be quite literally paying for your mistake down the line.

Review federal loans first. They tend to have the most favorable terms and flexible repayment options, and you generally don’t need a co-signer. To receive federal loans, families must submit the FAFSA form, with the 2016 – 2017 version available beginning October 1. Even if you don’t think your family will qualify for need-based aid, you should submit the FAFSA anyway. Every family that files one, regardless of family income level, is eligible for some type of federal student loan. You never know what you might be eligible for or how your family’s needs will change before the fall. There are different types of Federal Direct Student Loans, including Direct Subsidized Loans, Direct Unsubsidized Loans, and Federal Direct PLUS, among others. We will cover the specific differences between these loans in an upcoming post, but all of them are managed by the federal government. Some can be covered by debt forgiveness programs, like the Public Service Loan Forgiveness Program, but when you’re taking out a loan it’s best practice to assume that you will be paying back the entirety of the balance.

If you need more money, look into private loans. Federal loans are limited year-to-year, and if facing a tuition shortfall, you may need to look into private education loans. One of the best known private loan lenders is the company Sallie Mae, but private loans also come from banks, credit unions, and other lenders. In most cases you’ll need a co-signer. All private loans differ, but their interest rates may be fixed or variable and some require a minimum payment while still enrolled in school. You can learn more about the differences between the two types of loans at Studentaid.ed.gov.

When taking out loans, make sure you understand the terms of the loan. How will interest be charged? What is the grace period on the loan, that is, how much time will pass between graduation and when payments are due? Who will be the co-signer on the loan, if you need one? There are many factors to consider and like most aspects of the college process, the answers will differ among families. But with some research, you’ll feel more equipped to make the right choices for you. Good student loan borrowing is about being smart, making the right decisions, and doing what’s best for you and your family.