As a parent, it’s a proud moment when your child gets accepted into college. You’ve watched your child work hard throughout high school, and now they’ve been rewarded with admission to an expensive private university!
You are then hit with the realization that there is no way you can afford to pay for your kid’s education. As a parent, you need to focus on building your retirement savings and paying down your debt. Adding $40K to $100K of debt for your child to go to school doesn’t make financial sense.
Assuming that you don’t have six figures tucked away in a 529 plan and that you and your spouse make a healthy joint income (over $180,000), what are your options for funding your child’s college education?
Getting a Loan
If you and your spouse make over $180,000 in joint income, you are phased out of all the government’s tax credits, grants, and unique loan options. This includes Pell Grants, Supplemental Education Opportunity Grants, Subsidized Stafford Student Loans, American Opportunity Credits, and the Lifetime Learning Credit.
(If you make under $180,000, you have options, but we’ll save that discussion for a different day.)
This means your only options are federal loans and private loans.
Federal loans are loan options offered by the U.S. government. They should be the first loan option for your child because they usually cost less and have better repayment terms than private loans. Your child applies for a federal loan by filling out the Free Application for Federal Student Aid (FAFSA).
Many of these federal loans are subsidized and have fixed interest rates that range from 3.86% to 6.41%. Your federal loan limits will be between $5,500 and $12,000 per year, but they cannot exceed the cost of college.
If the loan is subsidized, then the federal government will pay the interest while your child is in school. On an unsubsidized federal loan, the borrower pays the interest rate. Your child can be awarded a subsidized loan based on financial need. Financial need will also determine the interest rate paid on the loan.
The downside to federal loans is that the amount of money that can be borrowed is limited, and the government can take part of the borrower’s wages or tax refunds if they fail to repay their loans.
Once your child’s FAFSA has been approved, three main types of federal loans may be offered. The first is the Perkins Loan, which is a fixed-rate loan that is awarded based on financial need. Not everyone will be eligible for this loan. The next type of loan is a Direct Loan, which anyone is eligible for. A Direct Loan can be subsidized or unsubsidized, and most high-income families will qualify for an unsubsidized loan. The final option would be a PLUS Loan, which puts the responsibility of repayment on the parent.
In general, you should pick your loan in the following order: Perkins, Direct, and PLUS.
Banks and other financial companies typically offer private loans. In general, these loans are costlier than federal loans and don’t provide repayment flexibility if the borrower is having trouble paying.
You may come across a few types of private loans. The first would be a State Agency Loan, which is a loan offered by the state where your child will attend college. Your next option would be a traditional bank loan, which is provided by most commercial banks. Finally, individual schools have loan options that are provided by the school’s financial aid office.
The primary benefit of a private loan is that the amount that can be borrowed is larger than a federal loan. If you shop around, you can find low interest rates. The lender will decide on loan eligibility based on the borrower’s credit score, ability to repay, and other factors. Most likely, if you go the private-loan route, you will need to co-sign the loan with your child.
The major downside about private-loan interest rates is that they are usually variable, which means the rate can change over time. You or your child will also be charged interest while your child is in school, and lenders are less forgiving to those who are suffering from financial hardship.
To most people, college seems like a great idea, but does it make sense to be $50K to $100K in debt when you graduate?
We have found that our clients who took out large loans to go to college typically regretted their decision and struggled to pay off the loans in their 20s and 30s. Before you or your child take out a loan, make sure that your kid’s potential career choice will give them the ability to repay the debt.
It’s imperative to understand that student loans cannot be discharged via bankruptcy. The loan will stay with the borrower for the rest of their life.
If you or your child are planning on going more than $15,000 in debt for undergraduate school, please consider meeting with a financial planner.
Here are some additional resources to assist you with the loan process:
- FAFSA Application: fafsa.ed.gov/FAFSA/app/fafsa?locale=en_US
- CFPB College Guide: www.consumerfinance.gov/paying-for-college
- CFBP Loan Guide: s3.amazonaws.com/files.consumerfinance.gov/f/loan.pdf
- Federal Student Aid: studentaid.ed.gov/sa/