If college is the dream, student debt is often viewed as a means of achieving that dream.
Unfortunately, many families are not careful about the financial decisions they make during this justifiably exciting time. These families risk the dream of college becoming a lifetime nightmare of student debt.
Both child and parent need to understand the realities and the danger of college financing. Not only is paying for college more difficult than it was a generation ago, it is significantly more difficult than it was just 10 years ago.
If you are returning to school later in life or funding college without parental support, the questions and analysis remain the same. Going about this process on your own just means you need the self-control to objectively review your options and your decisions to make sure your hopes and dreams don’t cloud your judgment.
College remains an excellent investment for most people. However, it isn’t always a good investment like it might have been in the past. Because this new element of risk exists, it is critical to consider the various options and to have a candid discussion about the smartest path.
The purpose of this article is to look at the various topics that should be considered.
Avoiding Doom and Gloom
As this article was written, I found myself trying to balance two competing concerns. On one hand, I don’t want to be the crazy guy in a tin foil hat warning that the end is near. On the other hand, there are real dangers and real risks that families need to discuss.
A parent’s job when discussing college isn’t to have all of the answers. A parent’s job is to ask the right questions and to help their child find the right answers.Parents will likely have an even more difficult time with this same issue. On one hand, you don’t want to rain on your child’s parade or crush their dreams, but at the same time, you want to protect them from the mistakes that many others have made and continue to make.
Where is the appropriate balance?
Finding the right motivation should be the key. As a parent you don’t want your child to make a decision they will live to regret. You don’t have any other agenda. You are not pushing them towards one school or away from another. Let the math and the analysis drive the discussion. Focus on the facts and the reality of the situation. Every college decision has consequences and some are easy to live with while others may not be.
How much can I afford to borrow for college?
The question of how much someone can afford to borrow for college is often overlooked.
Far too many simply track down the necessary student loans in order to meet the tuition bills each semester. To them, the big danger is not meeting their financial obligations for that semester. The real danger is not being able to meet their financial obligations for the next 30 years.
How much someone can afford to pay and how much someone can afford to borrow are two very different items. If a well funded 529 plan is in place or a family will be able to contribute significant assets to pay for school, an expensive education is much more affordable.
The question of how much a student can afford to borrow depends entirely upon their ability to repay the debt. The average graduate has student debt between $30,000 and $40,000. For some, borrowing this much money is an easy call and an excellent investment. For others it can be a devastating mistake with lasting consequences.
The easy rule of thumb is that total college borrowing should not exceed your expected first year salary. There may be some exceptions, such as medical school where new doctors are often poorly paid as interns and residents, but can expect dramatic salary increases as their career progresses. However, most people should target borrowing no more than the year one salary.
This means that how much you can afford to borrow depends entirely upon the school that you pick…
Picking a School
Fancy dining halls, a gorgeous campus, and luxurious dorms are nice, but the important thing to consider when picking a school is where it will leave you at graduation. Some schools have excellent career development offices and extensive alumni networks that make finding a job much easier and provide excellent starting salaries. Other schools invest far more in recruiting students than they do in helping them find jobs. (For-profit schools are notorious for dedicating most of their resources to recruiting students and providing little help finding a job.)
The key number that we have already mentioned is the expected salary at graduation. The more specificity you can get on this number the better. This means average salary for a specific program rather than school wide. The value of an electrical engineering degree is likely more than the value of a philosophy degree.
Watch out for language like “make up to” or “some graduates earn.” Everyone expects to be at the top of their class or a top job candidate, but obviously not everybody can fall into this category. Thus, it is critical to look at what life is like for an average or even a below average graduate.
Having conversations with recent graduates is often the best source of information. These people are in the exact position you hope to find yourself in a few years. How is their job hunt going? Was the school helpful? Are they worried about their student loans?
Keep in mind that the more you borrow, the more risk you are taking. If you think it is ok to borrow $100,000 because you expect to earn that much at graduation, it is critical that you get the degree you planned on. Failing to graduate with that level of debt would be truly devastating. As borrowing increases, pressure to find a good job will also increase. How many freshman become graduates at your school? How many people drop out of the program before completion?
How to get a Student Loan
If you have made the decision to borrow to help pay for school, there are many options.
The first choice for just about any student would be to get federal student loans. These loans are available to all students who complete the FAFSA. (Note: financial need will only determine whether or not the government will subsidize the interest… it has no bearing on how much you can borrow.) The borrowing limits vary by year of school. Once the FAFSA is completed, your school may have additional financial aid documents that need to be completed before the loan is formally offered.
Federal student loans are the best option for most borrowers because of the protections that are included on each loan. Federal loans come with income-driven repayment plans. On an income-driven repayment plan, a borrower is only required to pay a percentage of their monthly discretionary income towards their debt. These are the only loans with payments based upon how much you owe rather than how much you can afford. This is an excellent protection for borrowers who end up leaving school or are unable to find a job with a sufficient salary. These loans also come with various forgiveness programs to aid in repayment.
At times federal student loans do have higher interest rates than private loans, but the federal perks almost always justify paying a little more in interest each year.
After maxing out federal borrowing, things get more complicated. This is the stage where many individuals and families resort to either Parent PLUS loans or private student loans.
Parent PLUS Loans
Parent PLUS loans are loans borrowed by the parent rather than the student. This means that under the law, it is the parent’s responsibility to repay the loan as it is their contractual obligation. These loans come with limited borrower protections, and the interest rate is set high than other federal student loans.
The advantage to Parent PLUS loans is that the credit check is far more limited than what is required by private lenders. Unlike federal loans to the student, parents can borrow up to the cost of attendance each year.
Higher limits and higher interest rates increase the financial strain at graduation and during repayment.
If a Parent PLUS loan is selected, it is critical for the parent and child to discuss responsibility for the loan. A situation where the parent expects the child to pay the bill and the child expects the parent to pay the bill can be a major issue. Large Parent PLUS debt issues can hurt the parent/child relationship.
The Department of Education has an excellent informational handout on Parent PLUS loan basics.
Applications for a Parent PLUS loan can be found here.
Private Student Loans
Private student loans come in all shapes and sizes. Some of these loans have excellent interest rates while others have interest rates higher than a credit card.
Generally speaking, in order for a student to get a private loan, they will need a cosigner. Cosigning a loan is more than just vouching for the credibility of somebody. It is taking a legal obligation to pay back the loan if the borrower fails to meet their burden. This obligation can last in the event of a falling out, a divorce, or even the death of the primary borrower. (How a lender handles cosigners in the event of the death of a borrower varies from lender to lender.)
Each private student loan is a contract between the borrower, cosigner, and the lender. Various lenders use different contracts with different obligations. Unlike the many user agreements that we often sign without ever reading, this is a document that needs to be read from beginning to end. If there is questionable language, it might be a good idea to talk to a different lender.
For those that opt for a private loan, it is critical to shop around. Checking with many different lenders won’t hurt your credit score, but it will help you find the best interest rates and best terms. Services like Credible can help because it allows borrowers to check their rates with multiple lenders with a single application.
We should also note that the most desperate student loan situations often involve private student loans. These lenders offer little assistance to borrowers who cannot afford their payments and it is common to see borrowers who have to pay over half their salary towards their private loans. This video should be required watching for anyone considering private loans as it provides an excellent snapshot at what life can be like if you borrow too much.
Saving Money During School
One of the best ways to minimize borrowing is to find ways to cut costs and generate an income as a student.
Lenders are usually happy to provide the funds necessary for expensive housing during school, but choosing a more affordable option can make a huge difference during repayment.
Many students opt to “focus on their studies” instead of getting a job during school. Having a job and going to school makes for a busy schedule, but it also helps create excellent time management skills. Potential employers will also be impressed because it shows a strong work ethic.
Keeping Up with the Joneses
Perhaps the biggest mistake that any student or family can make is to assume they are making a smart decision because it seems like they are just doing what everyone else is doing.
The reality is that it is impossible to know how others are paying for school and it is dangerous to make assumptions. There are many resources that other students might have that can change their math.
Scholarships and Grants – Qualifying for scholarships and grants can have a huge impact on the affordability of a school. Many schools can be an excellent option with a scholarship, but at full price be a bad investment.
Keep in mind that others may be making a bad financial decision. They may be blissfully unaware that the next 25 years will be filled with hardship due to the debt they are racking up right now. Don’t assume your decision is justified just because others are making the same choice. Think for yourself.Family Resources – The neighbor family down the street that doesn’t seem particularly wealthy may have been saving for decades in order to pay for school. Just because someone else attends a particular school or program doesn’t mean borrowing to pay for it is a good idea.
This danger exists for more than just picking a school. It can also apply to conduct made during school.
A spring break adventure may seem like a nice opportunity, but not everyone can afford it. Some go even though they can’t afford it. If you opt for the school that offered a big scholarship and are earning money all year, spring break could be a deserved reward. If your borrowing is hitting dangerous levels, spring break could be an awful decision.
Student Loan Forgiveness
Planning on student loan forgiveness is dangerous.
Last week we looked at over a dozen different student loan forgiveness programs. While there are many forgiveness programs, the reality is that few borrowers actually qualify. There is also the danger in federal law changing an eliminating the program you are working towards.
We suggest that college students and graduates investigate and apply to forgiveness programs… but don’t make the mistake of assuming they will qualify. Over a third of the people actively pursuing the Public Service Loan Forgiveness program have had their application rejected.
The worst mistake that a borrower can make is to assume they will qualify for loan forgiveness and borrow excessively. This is a recipe for unmanageable debt levels and hardship.
Look at the big picture: Think Long-Term
In planning for college finances, don’t make the mistake of looking at one semester or even one year at a time.
Some programs routinely take four or even five years to complete. If you have decided that you can afford to borrow $50,000 in student loans, needing $15,000 for the first semester should be a red flag.
As college goes on, borrowing gets harder and more expensive. The more loans that are on your credit report, the more likely a lender is to deny an application or only approve a high interest rate. Unless you are at a school that guarantees fixed tuition for all four years, you can also bet that the cost of school will go up each year.
Graduate School Planning
If graduate school is potentially in the future, it should have an impact on undergraduate planning.
Even though a graduate degree can have a higher earning power, undergraduate students shouldn’t assume that it means they can borrow more for undergrad. In fact, they should do the opposite. This is because admission and completion of a graduate program is hardly a sure thing. Additionally, the job marketplace could look dramatically different than what it did when you started school. (As someone who finished law school during the peak of the recession, I’m speaking from personal experience on that point.)
Knowing that graduate school is in the future can often mean that less expensive undergraduate options are available. Many students get overly concerned with US News Rankings and college prestige. If you are majoring in political science with an eye towards becoming a lawyer, your focus should be on graduating with as little debt as possible. If the less prestigious school offers a big scholarship, go for it. Most graduate schools really only care about undergrad GPAs and test scores. At best, the name of the undergraduate school can be a tiebreaker.
Consider Transfer Options
Transferring schools should be given serious consideration.
Many students opt to attend a community college for a year or two and then continue their studies at a larger institution. This is a really savvy approach to getting an education. These students get the exact same degree as those who attend for four years, but they spend significantly less on the degree. At many larger schools the first and second year classes are large lectures. Cultivation of important professional relationships with professors normally happens the third and fourth year, when classes get smaller and more specialized.
Students who start at a community college also minimize the danger of dropping out. College is not for everybody. The only way to know for sure is to go. Some people complete a year or two and decide that college is not for them. Those that attend a more affordable school, will have much less debt to deal with than those who make that realization after attending an expensive private school for a couple years.
Another transfer option that should be considered is transferring from an expensive school to a less expensive school. If you attend a pricey business school for a year and decide to switch majors from business to education, it might make sense to also switch schools. By transferring credits to a more affordable state school, a student can correct a mistake before the damage gets out of hand.
Parents: Don’t Raid Your Retirement to Pay for College
Borrowing as little as possible in student loans should be encouraged, but not if it means dipping into mom and dad’s retirement reserves.
The analysis here is pretty straightforward. You can borrow money for college. You can’t borrow money for retirement.
Parents who are willing to sacrifice their future for their kids certainly should be applauded, but they need to realize that dipping into their retirement accounts affects their kids as well. If mom and/or dad can’t get by in retirement, it is the kids who will be supporting them. No parent wants to impose that burden.
If we flip the script and a parent chooses not to raid their retirement account to pay for college, it doesn’t preclude helping at a later date. Five years after graduation it may become more apparent that the elder generation has the funds to help. At that point, existing student debt can be paid down. Children may appreciate help rendered in this manner more than they would help at the time of college.
Paying for a college education should be a little scary. Student loans can be a very useful tool, but they are also a risk.
Choosing a school, major, and payment strategy all require careful consideration. Hoping for the best or assuming things will work out can jeopardize your financial future.
Many of the questions that need to be considered are not fun to think about, but the analysis can be done by anyone, and the rewards for smart planning last a lifetime.