College Countdown Part III: Should You Help with Their Loan?
In this last installment of our College Countdown series of articles, we will address the topic of student loans. There is a lot of excitement and pride that surrounds sending a child to college. But when, and sometimes even before, the hoopla wears off, there is the realization that the next four years are going to cost real money. Who is going to pay and how?
As parents, we want to assist our kids financially in their quest to earn their degree. But we also want to protect ourselves from spending our retirement savings and depleting our other resources. While our kids can get education loans, we can’t get retirement loans.
Let’s look at some options.
The U.S. Department of Education makes $112 billion in financial aid available each year to assist students in their pursuit of higher education. By filling out the FAFSA, or Free Application for Federal Student Aid, your child will find out their eligibility to qualify for federal aid.
Part of the financial aid offered to students includes different types of federal student loans, such as:
● Direct Subsidized Loans. These loans are based on financial need. Interest does not accrue while the student is in college at least half time.
● Direct Unsubsidized Loans. These are not based on financial need. Interest starts accruing as soon as the loan is disbursed.
In 2022, the federal loan money available to undergraduates is $5,500 for freshmen, $6,500 for sophomores, and $7,500 per year for juniors, seniors, and any extra undergraduate years of study. The college your child attends will determine the final amount of aid available based on costs and other financial aid or scholarships received.
When your child agrees to take out a federal student loan, they are borrowing money from the U.S. Department of Education to help pay for their college. Some pluses for the parent are:
Your child doesn’t need good credit or a cosigner. Federal loans are not based on creditworthiness, so teens can qualify for them. Parents are not on the hook as cosigners, so they are free from being responsible for loan repayment.
Lower rates. Federal loans have lower interest rates, which are usually fixed, and lower fees. These will be lower than any private loans available to the parent or child.
More repayment options. The average monthly student loan payment is $300. Whether your child finds employment immediately after graduation or not, the repayment plan can be adjusted or forgiven depending on their income, their choice to work in public service, or other factors.
Direct PLUS Loan
Direct PLUS loans, sometimes called the Parent PLUS loan, are federal loans to parents that can help make up for any difference between the cost of college and what the student loan covers. To qualify for this loan, you must be the biological or adoptive parent of the student and not have an adverse credit history such as bankruptcy, repossession, foreclosure, wage garnishment, or tax lien within five years.
While this loan allows the parent to borrow the cost of college attendance, minus any other financial aid received, it does come with some cons, including:
You, not your child, are responsible. Regardless of whether your student finishes school or not, you are responsible for repayment of this loan. It cannot be transferred to your child.
No automatic grace period. Most student loans give the student a grace period of six months to one year after graduation to start the repayment of the loan. With Parent PLUS loans, repayments start immediately after the money is disbursed to the school or student.
No repayment flexibility. If a parent is unable to make the loan payments, the federal government is able to seize their wages, Social Security, and tax refunds.
You are stuck with it. There is no getting out of a Parent PLUS loan. The debt will never be dismissed, even if you declare bankruptcy. The only way out is to pay it off.
Private loans can cover any gaps in funding that exist after receiving a federal loan, but they can be a risky way to pay for college. How are they riskier?
● There are higher borrowing limits, if you qualify, and that can lead to overborrowing.
● Private loans almost always need a cosigner, usually the parent.
● Interest rates may be variable rather than fixed.
● If your child has a hard time finding a job or one that pays well, and they are unable to pay their loan, you are responsible for payments. This could leave you with their student debt as you hit your retirement years.
● If your child were to die before they pay off the loan, as a cosigner you are required to pay it back. Some parents have resorted to purchasing life insurance on their child in the event of this happening.
Paying Off Their Student Debt
When students take out a loan, they have taken on a mantle of responsibility for their own education. They have some skin in the game, so to speak. And because it is their name on the loan’s dotted line, they may take their school studies more seriously.
After graduation, however, parents or grandparents like to help out their offspring by paying off some or all of their student debt. Is this a good idea? It depends on your situation.
Some questions to ask yourself include:
Can I afford to? As you get closer to retirement, you should be making any catch up contributions to your 401(k) account or other retirement accounts and working to pay off your mortgage. Diverting that money to pay off your child’s debt may shortchange your own retirement preparations.
Will I have to pay gift tax? Maybe. You may also have to file a gift tax return.
Are there alternative ways to help them? Perhaps paying off their debt isn’t an option for you or doesn’t appeal to you. There are other ways to assist your child, such as allowing them to move back home for a year rent-free while they are just getting on their feet.
We hope you have enjoyed our College Countdown articles! It is an exciting chapter of life for you and your teen. By thinking ahead and being prepared financially, you can successfully navigate your child’s college years.
Written by Matthew Delaney