Financing College – Tips for Parents and Kids
To borrow or not to borrow? That is not the question any more when it comes to college. As tuition rates rise each year, many Americans are forced to borrow to afford a college education for their children. The new question is how to borrow. Here are so things you need to know.
Savings v. Loans. All student loans or equity loans will accrue interest daily, starting on the day the loan was disbursed to the school. As most student loans accrue interest between 6-10%, whereas your savings account is probably only accruing 1-5% interest. The numbers make this decision easy. If you have put money aside for your children’s education, you should use those funds first. Do not borrow unless or until you must.
Children borrow first. This seems like common sense, but after working in the lending industry for years I can definitively say it is not. There are no loans for retirement. There are loans for college. Many parents tap into their retirement savings to put their children through school. However, no one knows what the future holds. What happens if you are laid-off or injured and unable to replenish those funds? You child does not have any legal liability to pay you back and may not be able too. Therefore, I always recommend that the child borrows before the parents, and before the parents tap into retirement funds.
Parent Borrowing Limits. Often parents take out loans or co-sign on loans without regards to if they can afford the loan. Underwriters are looking at if you can afford the loan based on your current income. But what happens if you retire within the next 5 years? Will you be able to afford the loan on your retirement income? The best piece of advice to parents is to make sure that you can pay the loans off in ten years or by the time you retire, whichever occurs first.
Student Federal Loans. The federal educational loans, of which there are several different types, offer the most forgiving repayment terms. After grants and scholarships are tapped out, you should always start with federal loans. There are no parent income limits for your child qualifying for Stafford Loans. There are two types of Stafford Loans, Subsidized and Unsubsidized. Almost every student will qualify for an Unsubsidized Stafford Loan, limits on the child’s borrowing are determined by their filing status as dependents. Unsubsidized are need-based loans, where the government will cover the interest on the loan while the student is in school. There are also need-based loans such as Perkins loans for undergraduates, which are also federal. The big tip with these loans, try to pay the interest that accrues monthly. When you sit down and discuss budgeting with your child be sure you know how much interest is accruing on their loans and discuss with them fitting interest payments into their budget. Why? Again, if it is not a subsidized loan, interest accrues daily. Not only that, but accrued and unpaid interest is capitalized upon graduation. What does that mean? It means that any unpaid interest is added to the principal balance of the loan. Interest then accrues on the original balance and the combined capitalized interest. In other-words, the student is paying interest on interest.
Parent Federal Loans. Again, the federal loans offer the most forgiving repayment terms. While some parents chose to co-sign, with the student being the primary borrower, Parent Plus loans through the federal government are the sole liability of the parent. Why should you choose this over co-signing? That is a tricky question that will depend on your financial situation. Parent Plus loans are good for parents with less than stellar credit history. Often, the interest rates are comparable too. Many parents chose Parent Plus loans over cosigning because they want control over the timeliness of payments. Do you trust your child to make payments on time? If you co-sign and they are late, it will be reported on both credit reports. Therefore, many parents choose to use Parent Plus loans to protect their credit.
Private Loans. Private loans are generally not recommended. They do not have the flexible repayment plans of federal loans and students almost always need a co-signer. Having worked in the lending industry, I can say that it is really difficult for a student to qualify for a co-signer release. To remove a co-signer the student typically needs a credit score above 650, a debt-to-income ratio less than 50%, minimum income of $45,000, and a full year of on-time payments. Most students do not qualify for a co-signer release for 5 to 10 years after graduation. Okay, what does that mean for the co-signer? As you are equally responsible for the loan, if your child pays late or fails to pay, so, you owe that payment and your credit will be affected. I saw way too many cases of families torn apart over these loans. Since the rates are not usually much better than federal loans, it is usually better just to stick to the federal loan programs.
Home Equity Loans. Do not do it! You are literally putting your house up as collateral. What happens if your financial situation changes? Do not risk your home.