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.

What you need to know about the 2016-2017 Parent Plus Loan

Summer is student lending season, as many are preparing to handle bill payment leading up to the new fall semester.  This can be a stressful time for parents managing an outstanding balance for college, especially if it’s a larger bill than hoped for.

July Parent Plus
Few more weeks, then back to school!

Even after scholarships and financial aid are made available, it’s not uncommon for families to rely on a Parent Plus loan to supplement the remainder of the bill.  Here are a few key things to consider when applying.

Interest Rate: For the 2016-2017 year, Parent Plus carries a 6.31%.  This is actually a lower rate when compared to prior years in this federal program.  It’s also a fixed rate loan meaning that the rate will not go up or down.  There has been ongoing discussion about the pros and cons of fixed rate loans given the very low interest rate environment of the past several years.  While locking in a fixed rate provides the security of a very predictable repayment process, if the fixed rate is rather high, it also guarantees the interest costs during repayment. It’s a matter of personal preference, but Parent Plus is only using a fixed rate.

Origination Fee: 4.276% This is an area of concern as a 4.276% origination fee seems pretty high for most consumers, especially when compared to other financial products. (Imagine if a mortgage had a similar fee…) The fee is taken out of the gross loan amount, actually reducing the loan disbursement to the school.  So if you apply for a $10,000 disbursement in the Fall semester, $427.60 is deducted from the amount, leaving $9,572.40 to pay the account.

Credit Criteria: The only requirement is that the parent borrower not have “adverse credit history.” This is defined as not having any 90+ day delinquencies on more than $2,085 in debt and not having any loan defaults, bankruptcy discharges, foreclosures, repossessions, tax liens, wage garnishments or had a federal student loan write-off during the past five years.  This allows for many to gain approval for the Parent Plus loan, as the application approval does not depend on the borrowers actual credit score or debt-to-income ratio.

Who is the lender? The lender is the Department of Education through the Direct Loans Program.  This is a government based student loan program.

What happens if denied?   When a parent is denied for Parent Plus, the student becomes eligible for an increase in Direct Unsubsidized Loans in the amount of $4,000 for freshman and sophomores and $5,000 for juniors and seniors.  Immediately inform the office of financial aid of the circumstances to coordinate the increased direct loan in the student’s name.  This has been an especially helpful way for some students to gain additional funding to cover a small balance when necessary.

More Parent Plus Tips:

Run a loan repayment calculation to estimate costs: It’s always a good idea to be aware of of future loan payments to make sure they fit in the budget. For example a $10,000 Parent Plus loan at 6.31% would require monthly payments $112 and cost about $3,509 in interest. If your a parent of a new freshman, take those figures and project them over the next 4 years.  You can quickly estimate about $40,000 in total loan disbursements, about $450 per month in payments and about $14,000 in total interest over total repayment, and that’s if the interest rate stays at 6.31%.  Remember to always look at the big picture of debt and consider what’s needed for the whole education, not just one year.

Increase the Parent Plus loan amount to compensate for origination fee: As noted earlier, the origination fee is deducted from the gross loan amount, reducing the actual disbursement to the school.  If using Parent Plus, make sure to increase the loan amount so that it can still cover the bill even after the fee is removed.  This avoids an end of semester problem of having an unpaid balance that everyone thought would be covered by the Plus Loan.  Some families end up scrambling for an extra $500 in cash just to pay that bill and get cleared for next semesters registration.  Instead, make it easy and apply for a larger loan.  If the school receives more loan money than needed, they can send the excess in the form of a refund check to the parent, and they can then make a payment to Direct Loans to lower the loan balance.

Compare to private loans or home equity: You have options.  Private loans are provided by banks and financial institutions and may offer an appealing program for some families.  They do have more stringent credit standards using the student as a primary borrower with a parent as a cosigner to establish approval. Some families prefer the private loan because it allows the parent the opportunity to utilize a cosigner release from the application once the student borrower makes a certain number of on-time payments after graduation. Not all lenders offer cosigner release, so pay close attention and compare during your application process. This differs from Parent Plus, that remains only in the parent name until repayment is achieved.  Home equity is another option for some families, especially where low rates can be made available.  This should be handled with care, as putting up home equity comes with it’s own unique risks as well.  Additionally, the debt would only remain with the original parent borrower, there would be no easy way to transfer the total debt back to the student like in a private loan with cosigner release.

 

 

 

 

 

John’s Jots #4: Defining College Affordability

Guess what – there isn’t a standard definition of an affordable college.   Google “Affordable Colleges” or “Is College Affordable for Me?” and you get a hodgepodge. No wonder families are overwhelmed when trying to figure out how they know if they can afford college or if they’re saving enough. How can families assess the financial fit of a college when the “experts” can’t agree on what it means for a college to be affordable?

I’d like to solve this problem for families.  I’ll tell you what I think — let me know if you agree or not — with the hope that we can start to demystify this important question.

First, despite the current good-faith efforts by many, my google search for “Affordable Colleges” amplified the problem.  The returns included:

  • The 100 most affordable colleges — after community colleges and others were eliminated from the sample.  But those that were eliminated are likely very affordable options.
  • Affordable colleges ranked by ROI — a measure that many champion as “the answer” which may be true if you can accurately predict a student’s future income and the total cost of college before your student enters.  Although I like ROI calculations and it’s a financial term that many use because it sounds sophisticated, its fundamental  value is as a backward looking comparative tool.  Like all such measures, the output  can only be as accurate as the inputs, which in the case of predicting college costs and post-graduate wages are highly variable, at best.
  • Affordable colleges ranked by annual tuition and expected income — the winners were the U.S. Naval Academy and West Point, which don’t charge tuition but require a highly selective appointment.
  • Advice to attend a community college for two years, then attend a state school, live at home, buy used textbooks, work at a paying job during the summer and avoid debt.

All good — but not particularly specific to guide a family. So I tried to narrow the search by asking “Is College Affordable for Me?”  I hoped that would give me more personal financial advice.  Here’s what I found:

  • A U.S. Department of Education Blog, which is mostly cheerleading about the  Administration’s efforts. The efforts, like most high-level policies are well intended, but don’t specifically help me unless I like to eat tax credits.
  • Many articles arguing to make some colleges free — likely driven by the election sound bites to make community colleges free.  A interesting political idea but somebody’s still going to have to pay for the college experience.  In this case, taxpayers.
  • A link to The Lumina Foundation’s excellent study arguing that a college is affordable if the total cost of a bachelor’s degree does not exceed the total of 10% of a family’s discretionary income over 5 years plus the amount a student can earn working 10 hours per week during the school year.  It’s mostly applicable to lower income families but is a useful guide.

Kudos to Lumina for more good work and an attempt to address the issue.   But what’s the answer for most families?  How does a family know if a college is affordable?

There are 5 factors that determine if a college is affordable without taking on debt:

  1. The college selected. Families have  COMPLETE control over this important part of the equation.   There are over 7,000 colleges and  universities — one will certainly be a good academic, social and financial fit.  Picking a college based on cost is one sure fire way of ensuring that it is affordable.  The problem: many, if not all, students and parents have a pre-conceived notion (their dream, which I completely get) of the type or specific college they seek, so many choose higher cost alternatives than they may need.  Knowing the student’s longer-term goal is helpful. Do they want/need a job after college or is grad school an immediate option?
  2. Family Income.   Financial aid is mostly driven by family income – not assets.  Need-based aid is readily available at most colleges — and some of the most selective colleges provide 100% aid for low income, high achieving students.
  3. Savings. How much will likely be saved by the start of freshman year?  Very few families will save 100% but establishing a savings plan early  — and contributing routinely — will make a big difference.
  4. Getting “Free Money.”   Grants and scholarships will help defray college costs.  In addition to federal, state and third-party grants and scholarships, many colleges offer generous Merit Aid to students who help the college fill-out the entering class.  The college may be seeking an actor or thespian or woman/man from a particular geographic area and will offer lots of money to them. Other times gifts from relatives and others help students cover college costs.
  5. Current Income.  Will parents and/or students be able to contribute cash while the student is in-school?

If these sources cover the full-cost of college (tuition, fees, room/board, other projected expenses such as travel), the college is affordable.   If there is a gap, the discussion gets more interesting because loans are now necessary — and this is where parents and students get into trouble.

Part of the problem: the federal government allows schools to include loans as “aid” in Financial Aid Award Letter  — including a Parent PLUS loan that is offered for the full amount of attendance with little  regard for whether the parents can actually afford the loan.  So the college indicates that it is affordable — based on packaging a boat load of loans without regard to a family’s capacity to repay them.  Sometimes, schools will also front-end load grants or scholarships that might not be renewed or available after freshman year.   Again, the college may appear to be affordable, but maybe only for freshman year.   It’s mind-boggling but true.  It’s like walking into a car dealership and getting a “no questions asked” loan to buy a Mercedes.   The dealer will no doubt think:  Enjoy the great drive — until we repossess the car because you can’t afford the loan payments (which, by the way, we knew before you drove away).  Don’t let this happen to your family!

In my world, a college is affordable if — after exhausting 1-5 above — the student or parents need a loan to fill the gap and BEFORE taking a loan consider:

  • Student’s post-college life.   Students needs to avoid the trap of simply taking big loans to attend the school of their dream without first UNEMOTIONALLY and REALISTICALLY thinking about what their goals are after college — how much are they likely to earn per month?  Before signing for the first loan, determine how much debt is likely to be necessary over 4 years and see what the monthly payment will be — for 10 or more years after graduation.  There are a few rules of thumb on this: Don’t borrow more than your first year’s starting salary. Don’t borrow more than 15-20% of your projected monthly disposable income.  If the monthly payments do not line up with projected income, that college doesn’t sound affordable to me.
  • Parent’s life style and retirement plans if they co-sign their students or take parent loans.   If parents take on debt to pay for their child’s education, they’re best advised to understand what it will mean to carry that debt for 10 or more years after graduation, which just may happen to coincide with their planned retirement.   Will the college debt extend the number of years they  have to work or substantially reduce the amount of their available retirement savings?   Do they plan to borrow against retirement savings?   If so, that college doesn’t sound affordable to me.

This may all sound simple. Theoretically it is:  choose a college that is affordable and offers a social scene and academic rigor in line with your student’s abilities and interests. We should also consider how the student can make progress from the challenges they face in college.  Ideally they are given the opportunity to learn from failure after giving their best efforts towards something they are passionate about.  Not everything has to be perfect to make for a great learning experience.  The result will be a happy, empowered college graduate who, like fearless Felix Baumgartner, lands on his feet: with a diploma in hand, a well-paying job, and student loans, if necessary, that are manageable.   And parents who have helped their child successfully navigate this process without putting their retirement or life style in jeopardy.

Let me know if you disagree with this train of thought — and why. Together we can help families grapple with this vexing issue.

 

 

 

 

Provide the benefits of better college planning

So many great benefits are being provided to employees through smart use of technology combined with insightful knowledge.  Just take a look at how employers like PwC are providing student loan repayment programs with Gradifi, or how companies can utilize Student Loan Genius to encourage employees to successfully repay student loan debt, even going so far as to match payments like a 401(k).

But all this focus on student loan debt begs the question:

Wouldn’t it be better if students could finish college with less debt in the first place?

Invite Education offers a complete planning platform that’s perfect for families managing the college process as early as Pre-K all the way to senior year of high school.  We make college savings the first priority to help families take control of their future plans. Along the way, as the student progresses grade by grade, admissions and testing criteria are highlighted in preparation for the academic competitiveness involved.  As college nears, scholarships and financial aid are highlighted along with cost analysis and comparisons to help finalize school choice.  Finally, after all other funding avenues have been secured, student lending insight is provided to help families make wise decisions about debt.

Taking the “big picture” approach helps benefit long term planners with smart college decisions early helping to ease future student loan debt burdens.  Some parents may still be paying off their student loans now, and want to find a better way to help their child.  You can make this program available for your employees 24/7 and customize it to fit with your pre-existing benefits package.

Invite Education: Are you ready to Learn More?

Request A Demo Today