When we think about college, it is often in the context of our dreams. Seeing a child reaching their potential can be a dream come true for a parent. Unfortunately, the harsh reality of the dream is that planning and paying for college can be a major hardship.
Sadly, 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 dangers of college financing. Not only is paying for college more expensive than it was a generation ago, but it is also significantly more complicated than it was just ten 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 means you need the self-control to objectively review your options to ensure 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. A candid discussion about the smartest path is essential.
The purpose of this article is to look at the various considerations that go into planning and paying for college.
Smart College Planning for Parents and Students
When I wrote this article, I found myself trying to balance two competing concerns. On the 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. Parents don’t want to rain on their children’s parade or crush their dreams. But, at the same time, parents 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?
Affordability is an essential element of planning and paying for college.
Many student loan borrowers are only concerned about getting a loan as quickly and easily as possible. To these students, the big danger is not meeting their financial obligations for that semester. However, the real danger is not being able to meet their financial needs 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 contribute significant assets to pay for school, an expensive education is much more reasonable.
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.
The school you pick affects how much you can afford to borrow…
Picking a School
Fancy dining halls, a gorgeous campus, and luxurious dorms are nice, but consider 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 outstanding starting salaries. Other schools invest far more in recruiting students than they do in helping them find jobs. For-profit schools, for instance, are notorious for dedicating most of their resources to recruiting students and providing little help finding a job.
As we previously mentioned, the expected salary at graduation is a key number on which to focus. The more specificity you can get on this number, the better. This means the average salary for a specific program rather than school-wide. The monetary value of an electrical engineering degree is likely higher than that of a philosophy degree.
Watch out for language like “earn up to” or “some graduates make.” Everyone expects to be at the top of their class or a top job candidate, but 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. A less valuable degree could make the larger amount of debt a significant struggle. Worse yet, failing to graduate with that level of debt would be truly devastating. As borrowing increases, the pressure to find a good job will also increase. How many first-year students become graduates at your school? How many people drop out of the program before completion?
Picking more than one school – Sometimes the best option is to pick multiple schools. Students who start at a community college can dramatically reduce borrowing and eventually graduate from a top school.
How to Get a Student Loan
If you have decided 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 depending upon how long a student has been in school. Upon completing the FAFSA, your school may have additional financial aid documents to complete before the loan becomes available.
Federal student loans are the best option for most borrowers because of the protections included on each loan. Federal loans come with income-driven repayment plan options. On an income-driven repayment plan, borrowers pay a percentage of their monthly discretionary income towards their debt. These are the only loans with payments based upon how much you can afford rather than how much you owe. This is an excellent protection for borrowers who end up leaving school or are unable to find a job with a sufficient salary. Federal student loans also come with various forgiveness programs to aid in repayment.
At times federal student loans 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 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 the parent is contractually obligated to repay the loan. This kind of loan comes with limited borrower protections and the interest rate is set higher than that of other federal student loans.
The advantage of 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 only 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 in which the parent expects the child to pay the bill and the child expects the parent to pay 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 Parent PLUS loans are found here.
Private Student Loans
Private student loans come in all shapes and sizes. For example, some have excellent interest rates, while others have interest rates higher than a credit card.
Generally speaking, for a student to get a private loan, they will need a cosigner (what some lenders now call a “co-borrower”). 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 endure through a falling out, a divorce, or even the death of the primary borrower. Note: 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 they allow borrowers to check rates with multiple lenders in 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. 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 of 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 massive 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 they are doing what they think everyone else is doing.
The reality is that it is impossible to know how others are paying for school and it’s dangerous to make assumptions. There are many resources that other students might have that can change their financial planning.
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 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. For example, a Spring Break adventure may sound fun, but not everyone can afford it. Despite this, some go on a Spring Break even though they can’t afford it. If you opted for the school that offered a big scholarship and you earned money all year, Spring Break could be a nice 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 various student loan forgiveness programs. While there are many forgiveness programs, the reality is that not all borrowers actually qualify. There is also the danger of federal law changing and eliminating the desired program.
We suggest that college students and graduates investigate and apply to forgiveness programs… but don’t make the mistake of assuming they will qualify. For example, the Public Service Loan Forgiveness program has a very high rejection rate.
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 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. They should do the opposite. Admission and completion of a graduate program is hardly a sure thing. Furthermore, 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 Great 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 intending to become 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 only care about undergrad GPAs and test scores. At best, the name of the undergraduate school can be a tiebreaker.
Consider Transfer Options
When discussing planning and paying for college, transferring schools should be given serious consideration.
Some students opt to attend a community college for a year or two and then continue their studies at a larger institution. This is a savvy approach to getting an education. These students get the same degree as those who attended for four years, but they spend significantly less on the degree. Furthermore, at many larger schools, the first and second-year classes are large lectures. Cultivation of important professional relationships with professors typically occurs in the third and fourth years 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 of years.
Another transfer option to consider 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 change 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 likely 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 apparent that the older 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. There is a strong argument to be made that student loan repayment assistance is more useful than tuition help.
Planning and Paying for College
Planning and paying for a college education should be a little scary. Student loans can be a handy 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 to consider are not fun to ponder. However, anyone can do the analysis, and the rewards for smart planning last a lifetime.