Any parent with a child about to head off to college should be concerned about student debt. Used properly, student loans are an excellent tool to further educational opportunities and to build a better future. Used improperly, student loans are a recipe for financial hardship. They are easy to get, grow quickly, and unlike any other form of consumer debt, they are almost impossible to discharge in bankruptcy.
While the stakes may be high, the good news is that there are simple steps that any family can take that will significantly decrease the odds of a student loan nightmare.
Teach Financial Responsibility
Nearly all of our tips for parents relate directly to the subject of student loans, but the most important one of all doesn’t specifically deal with student loans.
Perhaps the best way to avert any student debt disaster is to teach personal finance responsibility. In many homes money is something that isn’t discussed in polite conversation. Some parents may not think the family finances are the business of children, while others might be embarrassed. Regardless of the situation, there are important lessons that can be passed on to the next generation. Lessons learned at the dinner table can become lessons that don’t have to be learned the hard way.
If mom and dad refinanced the house and it freed up enough money to pay for the family vacation, share this information with your teens. Teach them about things like interest rates and real world consequences. If family finances dictate buying an affordable used car instead of a new SUV, talk about the budget and the available options. Encourage kids to save and reward their efforts.
Sending your child off to college with an appreciation for the value of a dollar and an understanding of the many basic financial skills not taught in high school will help them make better decisions as adults.
Federal Loans are Preferred
When it comes to student loans, borrowing directly from the federal government is almost always better than choosing a private lender. While there are downsides to federal loans, such as loan origination fees and interest rates that are not the lowest available, the positives outweigh the negatives.
Federal programs such as income-driven repayment plans and student loan forgiveness make federal loans the safest choice. Students who don’t find jobs with sufficient salaries to pay off their debt can use income driven repayment plans to ensure that no more than 10% of their discretionary income is applied towards federal loans. This benefits borrowers in a multitude of situations, ranging from those who can’t find jobs to high earners looking for a strategy to pay down debt or free up income.
It should also be noted that all students are eligible for federal student loans. The FAFSA may say that your family makes too much money for a subsidized loan, but that just means the government won’t pay the interest during school. Even the children of Bill Gates could get a federal student loan if they wanted to.
Watch Out for Sharks
Higher education is a business. In the business of higher education there are many sharks whose only purpose is to make a buck. They should be avoided.
At the top of the list are the many for-profit colleges who have been the subject of consumer complaints, lawsuits, and the cause of numerous student loan nightmares. These schools spend a fortune on advertising and recruiting students but very little on helping students find jobs once they get a degree. Pay close attention to job placement numbers, and career development office sizes. If graduates are complaining or the school has been sued by students or the government, you probably want to steer clear. In many cases, a local not-for-profit community college is much more affordable and will provide a more valuable degree.
Private student loan lenders should also be carefully evaluated. Many run their businesses in an ethical transparent manner… and many do not. Pay close attention to things like loan origination fees and interest rates. If a private student loan is required, be sure to shop around to find a low interest rate. Finally, keep in mind that lenders make decisions solely on whether or not they think the loan will get repaid. Just because you can get the loan doesn’t mean it is a good idea.
Make Sure the Investment is a Good One
Smart college spending has never been more important. A generation ago, nearly all college degrees had value that exceeded the cost of the education. Student debt was considered “good debt” by many. Those days are over.
A basic rule of thumb that we like to use is that total borrowing should not exceed the expected starting salary. This is obviously a highly simplified rule, but it provides a good starting point for college investment analysis. Going deep into debt for medical school makes far more sense than going deep into debt for an art degree. The fact is that some jobs pay more than others and this pay disparity needs to be carefully considered before going into debt.
Another reality that should be confronted is that fact that not all students who head off to college leave college with a job and a degree. Some get a degree but can’t find a job. Others don’t finish school. Nobody sends their kids off to school expecting them to not finish or not find a job after, but it happens every year. Believing in your child is great, but mortgaging their future or yours on college success is dangerous. Have a plan in place for if things don’t go according to plan. If you don’t have a backup plan in place, or can’t think of one, you may be making a bad investment.
Remember: This is a team effort!
Paying for college may seem overwhelming or complicated. Some families may feel it is the responsibility of the child to answer the difficult questions now that they are an adult. Others may see it as the parent’s responsibility to fund school.
The reality is that it needs to be a thoughtful family endeavor. The more discussion and insight that goes into the project, the better the outcomes will be. Dreams should be discussed as should fears. Alternatives should be proposed and considered.
The process can be difficult, but it can definitely be done. The time and effort put into preparation and planning will pay lasting dividends in the long run.