A parent trying to help her child find student loans to cover the remaining cost of school sent us the following email:
My son has taken out subsidized and unsubsidized federal loans, and he has much in scholarship and grant money. He still needs about 14K for the school year. I have excellent credit but want him to have skin in the game, so I am trying to help him find the best loan. I’ve about given up and had thought to simply take out a loan at great interest.
It’s so discouraging reading the horror stories.
What is the best way to handle this? Parent PLUS has a higher interest rate than private loans, and Sallie Mae has a lower rate than the Parent PLUS but, I am not sure what to do. SoFi advertises great rates, so that’s another option.
What do you think?
Student Loan Shopping Basics
Based on this email’s well-thought-out questions, we will assume that this family has decided that 14k in student loans is acceptable borrowing for this school year.
If your family is in a similar situation, you must answer the “should I borrow 14k?” question before answering the “what’s the best way to borrow 14k?” question. $14,000 may not seem like a ton of money for a college education, but over four years, that adds up to $56,000, and we haven’t even addressed the interest. Before borrowing, it is essential to make sure you can afford the payments before getting the loan(s).
Essential Items to Discuss: Every family should discuss their plan to pay for college. These discussions are not easy, but facing hard truths in the present can prevent major hardships in the future. Be sure everyone understands the considerations that go into funding a college education. For some students, pursuing a four-year degree while borrowing minimal student loans is the ideal approach.
Finally, any family considering a private loan should first maximize the student’s federal loan borrowing through the FAFSA. Don’t worry about your family’s income being “too high” for FAFSA loans… financial need only dictates whether or not the interest is subsidized during school. Because the federal government limits borrowing by undergraduate students, families often find themselves in the same shoes as our reader.
If you do find you have to borrow additional money, the question then becomes…
Who should sign for the loan?
There are three possible answers to this question, and all of them have distinct pros and cons.
Option 1: Only the student signs
The huge pro for this route is that loans in only the student’s name won’t impact mom and dad’s credit for what could be decades. As our emailer pointed out, this is also the best way to make sure your child has “skin in the game.” The major downside is that the student may not qualify for a loan on their own. Even if they do, they could end up with a high interest rate.
Option 2: Only the parent signs
By having just a parent sign for the loans, there are a couple of advantages. First, a parent with an established job and credit history can qualify for better interest rates than an unemployed college student. Second, having the debt on someone else’s credit report will make it easier for the student to buy a house in the future.
Parents have the option of borrowing private loans or selecting a Parent PLUS loan through the federal government.
If there is any concern about mom or dad’s ability to pay back the loan (if the student can’t help), a Parent Plus loan is a route to consider. These loans do not offer the premium repayment plans that normally go with federal loans, such as Pay As You Earn or Income-Based Repayment. However, some built-in protections provide assurances that private loans can’t match.
If the parent can definitely afford the student loan repayment should the need arise, they should find the lowest available rate on the private market. When shopping around, be sure to avoid origination fees and adjustable-rate loans that could skyrocket if interest rates go up across the board. Finding such a loan in just the parent’s name might be tricky, but it could be a good deal in the long run.
Option 3: Parent co-signs the loan
This is probably the most common route, though not necessarily the best. The advantage here is that the student has “skin in the game” but can get better interest on the loan because mom or dad also signed the loan. One downside to having two people on the loan is that it will appear on both credit reports and could potentially limit borrowing in the future. This is a significant consideration if you are thinking about starting a business or buying a home.
The biggest downside is if things don’t go according to plan. IF the student fails to make payments, the lenders won’t think twice about collecting the debt from the parents. IF you co-sign, you must be ready, willing, and able to pay for the debt.
Lenders have also engaged in some strange business practices with co-signed loans. The most egregious one is probably the practice of auto-defaults. Should the co-signer die or declare bankruptcy, some lenders require the loan balance to be immediately paid back in full. The moral of the story: read the fine print on the loans before you sign, and have backup plans in place if the unexpected happens.
The Best Approach
While the cost of attendance and family finances vary greatly from situation to situation, there are a couple of steps to follow.
Make finding a student loan a collaborative effort.
Having students pick out loans by themselves is a mistake. Parents, especially those that co-sign, should help shop around and read the fine print.
The reverse also holds true. Parents should not do all the work and then have their child sign for the loan. All students need an understanding of their responsibilities when it comes to the debt.
Have “skin in the game” from day one.
The average college student has no appreciation for the competitiveness of the job market. Asking an 18-year-old to make an informed decision about tens of thousands in student debt is a nearly impossible task for even the most mature high school student. For this reason, it is critical to show them what it means to have a monthly student loan payment.
The best way to teach this lesson is to require your child to make interest payments during school. They are paying much less than they will at graduation, but it is a monthly reminder of their future burden. Plus, as the student loan balance grows, the monthly payments will also grow. Students who understand the consequences of their college spending will be more likely to be frugal and take out less debt. Plus, if they ever have to take out an additional loan, they will be careful to find the one with the best interest rate.
From a parent’s perspective, if you want your child to be responsible about their debt, tell them you won’t sign for future loans if they don’t pay off the interest each month.
During school is the perfect time to build good financial habits. If the student misses an interest payment, in most cases, there are no late fees or negative credit reporting because the required repayment typically starts six months after school ends. Parents can track their student’s progress, and the student can establish the good habits necessary to avoid late fees and extra interest.
Perhaps the biggest perk of this approach is that you don’t take a beating at the hands of compounding interest. The amount borrowed is the amount owed at graduation.
Finding the Best Student Loan for your Child
Much like picking a college, picking a student loan is a significant decision. Combining family and finance can be a combustible mixture, so take the time to put together a well-researched plan.
Families that elect to go with a private loan will need to shop around. This is because each lender has a different formula for determining the interest rates offered. Often, the lender advertising the lowest rates will not be the lender that actually offers the lowest interest rate. Some lenders may place a bigger emphasis on mom and dad’s income, while others might care more about the students major and college choice. One of the easiest ways to shop around is to use a tool like Credible to find the best loan. Credible has partnered with many different lenders so that applicants can fill out one application and see prequalified rates offered by many lenders.
Putting everything together, three basic questions must be answered by any family:
- Is borrowing money for this education a good idea?
- If borrowing is a good idea, what sort of loans should be considered?
- If a private loan is the chosen route, have we found the best loan available?
Parents Should do More than Help Their Child Find Student Loans
Colleges do a great job of presenting options to pay for school and ensuring that families get the money they need to pay tuition.
These financial aid offices may be the best experts available, but their interests are not 100% aligned with the student. The main objective of a financial aid office is to get the classes paid for. The student is largely on their own when selecting the best route to pay for school.