Q&A: Best way to pay for college

Dear Liz: We have two children in college, both entering their junior years. We have two more in high school. The two currently in college need additional financial assistance, as they’ve tapped out their federal student loans.

We are middle class, grossing about $125,000 a year, so we don’t qualify for much financial aid. We’re considering a cash-out refinancing of our home, but we feel as though we can do it only once, since each time we refinance it will cost us some fees, plus interest rates are likely to start edging up soon.

However, if we take out a big chunk of cash that could last us for the next two years for the first two children, and possibly some for the other two, we’re concerned that having that much cash sitting in the bank will reduce the amount of financial aid we receive, which would be counterproductive.

Is there a way to earmark the extra cash clearly for education expenses so that it doesn’t count negatively on our Free Application for Federal Student Aid (FAFSA)? Or do we just need to take this year’s cash out now, and refinance again each year (which seems crazy)?

As an aside, now that we have a little experience with this college thing, we will guide the two younger ones to community college or living at home while attending a less expensive public college, or something along those lines.

The first two just sort of went — without a lot of financial forethought.

Answer: The chunk of cash from such a refinance would be counted as a parental asset, provided the savings account is in your names and not those of your child.

So a maximum of 5.64% of the total would be included in any financial aid calculations. That’s not a big bite, but if you’re not getting much financial aid it could offset or erase the small amount you’re getting.

The bigger danger is that you’re taking on debt for something that won’t increase your own wealth or earning power. If you should suffer a severe-enough financial setback, such as a layoff, you could wind up losing your home.

In general, parents shouldn’t borrow more for their children’s college educations than they can afford to pay back before retirement — or within 10 years, whichever is less.

This rule of thumb assumes that you’re already saving adequately for retirement and will continue to do so while paying back the debt. If that’s not the case, you shouldn’t borrow at all.

If you’re going to borrow and can pay the money back quickly, a home equity line of credit may be a better option than a refinance. Interest rates on lines of credit aren’t fixed, but the costs are significantly less and you can withdraw money as needed.

Yet another option: parent PLUS loans, which currently offer a fixed rate of 6.84%. Approach these loans cautiously. It’s easy to borrow too much, since the program doesn’t consider your ability to repay. And like federal student loans, this debt typically can’t be erased in Bankruptcy Court.

Q&A: Paying off student loans vs saving for retirement

Dear Liz: I’m engaged to be married and need your advice on getting started in the world of shared finances.

My fiance is 43, I’m 31. He’s debt free, with a savings account but no retirement fund. I have $34,000 in student loans (consolidated at 4.25%) and it weighs heavily on my mind as I’m desperate to become debt free. I’m debt free otherwise with $10,000 in savings.

We both make good money but my income as a freelancer is sporadic, while his is steady with periodic bursts of additional income.

We want to be debt free as a couple, save up a solid emergency fund and start making up for lost time on retirement savings, all while being aware that a family and a house might not be far away.

He’s very supportive and wants to pay off my student loans. Should I let him and pay “us” back to the emergency fund or maybe a house down-payment fund? What’s our best course of action to start on a solid financial footing?

Answer: You’re already behind on retirement savings, which should have started with your first job. Your fiance is even farther behind.

Don’t let your zeal to repay your debt blind you to the very real risk that you might not be able to save enough for a comfortable retirement if you don’t get started now.

If your education debt consists of federal student loans, then your low rate is fixed. The interest probably is tax deductible, which means the effective rate you’re paying is just a little over the inflation rate. It isn’t quite free money, but it’s pretty cheap.

You don’t need to be in a rush to pay it off, particularly with all your other financial priorities looming.

Instead, get going on some retirement accounts. Your fiance should take advantage of his workplace plan, if he has access to one.

Most employer-sponsored workplace plans have company matches, which really is free money you shouldn’t leave on the table. An individual retirement account or Roth IRA can supplement the plan or be a substitute if he doesn’t have access to a workplace plan.

As a freelancer, you have numerous options for setting aside money for retirement, including Simplified Employee Pensions (SEP), Savings Incentive Match for Employees (SIMPLE) and solo 401(k)s that would allow you to contribute more than the standard $5,500 annual limit for an IRA.

Ideally, you would be saving around 15% of your income and your fiance 20% or more.

If you can’t hit those targets just yet, start saving what you can and increase your contributions regularly. Work your other goals around the primary goal of being able to afford a decent retirement.

Q&A: Co-signing student loans

Dear Liz: I have two kids heading to college. Both need co-signers for their student loans. Will me co-signing have a negative effect on my credit? The kids have no choice. I’m middle class, having made enough to get myself by as a divorcee, but there’s no college savings. To make matters worse, I make just over the base for them to get a Pell Grant. I’m concerned about my credit, but my kids need to go to college.

Answer: Your children probably do need to go to college if they want to maintain a middle-class lifestyle in the 21st century. They probably don’t need to finance that education with private student loans, which are the kind that require a co-signer.

Co-signing means the loans show up on your credit reports. Your credit scores can be trashed if your children miss a single payment. If they stop paying, the lender will come after you for the balance.

Federal student loans are a much better option. They have fixed rates, numerous repayment options and the possibility of forgiveness.

Private student loans typically have none of those attributes. Quite the opposite: There are horror stories of private lenders that refused to forgive the balance of borrowers who died, leaving co-signers on the hook.

The big problem with federal student loans is that the amount your children can borrow is limited.

A first-year student typically can borrow just $5,500 and usually no more than $31,000 for an undergraduate degree. The average net cost of a public four-year university — the sticker price for tuition, fees, room and board minus grants and scholarships — was just under $13,000 in 2014-15.

That leaves a fairly substantial gap to cover, especially with no savings and two children.

If you can’t cover the gap out of your current income, your family needs to consider some options. Finding more generous colleges might be one.

Institutions vary tremendously in their willingness to meet families’ financial need. While few meet 100% of a typical student’s need, the more generous shoot for 90% or more. Some meet less than 70%. (You can find these need statistics, and many others, at the College Board’s Big Future site, at http://bigfuture.collegeboard.org.)

You also could consider a couple of years at a community college. There are some one- and two-year technical degrees, typically in the health and science fields that pay more than the average four-year degree.

Or your children could attend community college to get some requirements out of the way cheaply before transferring to a four-year school, but be aware that the dropout rate at two-year schools is high, even for students who start fully intending to complete a bachelor’s degree.

Another option is for you to borrow, but you shouldn’t consider doing so unless you’re saving adequately for retirement and can continue to do so while paying off the loans. Federal PLUS loans offer fixed rates, but if you can pay the loan off quickly, a home equity loan or line of credit may be a less expensive option.

Q&A: Student loan forgiveness

Dear Liz: I have $105,000 in medical school loans with an interest rate of 2.875%. I have another consolidated federal loan at 6%. I’m making $180,000 in the private sector and like my job.

Should I consolidate everything, try to get a public sector job, and apply for loan forgiveness after 10 years while paying as little as possible? Or should I accelerate my loan payments?
I would be able to pay almost the full amount after 10 years. I’m also trying to save for a house in a high-cost area. I have about $110,000 in savings and stocks.

Answer: Why would you upend your life to qualify for help you don’t need?

Loan forgiveness and federal income-based repayment programs are intended for those struggling to pay their education debt. These programs are available only for federal student loans, by the way.

The low interest rate on your medical school loans indicates that those are private student loans, which wouldn’t qualify for the relief programs or for a federal consolidation loan, for that matter.

So the question really is whether you should pay your loans off over time or try to retire them as quickly as possible.

A slower repayment schedule could allow you to buy a home sooner and save more for retirement, which are both worthy goals. Faster repayment could lower the overall cost of the debt and leave you less vulnerable to rate hikes, since the interest rates on private student loans are typically variable.

There’s no single right answer, but it’s a good question to discuss with a fee-only financial planner who can assess your entire financial situation and explain your options.

Q&A: Financial aid and divorce

Dear Liz: My ex-wife and I are about to start the financial aid process for our eldest child, who goes to college in the fall. My ex happens to have a higher income than me, and has asked me if I’d be willing to have different aid scenarios calculated based on our different incomes and assets. From all the research I’ve done, though, it seems she is the one who needs to file the Free Application for Federal Student Aid, since she’s the custodial parent. It’s not possible to choose who the custodial parent is for the purposes of financial aid, right?

Answer: It may be possible, but you have to make the choice well before you file the FAFSA form.

For federal financial aid purposes, the custodial parent whose information is used to calculate financial need is the parent with whom the child lived the most during the 12 months before the FAFSA is filed. With joint custody, the custodial parent is typically the one who provided the most cash support.

Some divorced parents opt to revise their children’s living arrangements so that the lower earner becomes the custodial parent. That may require a trip to court to revise a custody agreement. Also, the financial situation of any stepparents would have to be part of the equation, since the income and assets of the custodial parent’s spouse (the stepparent) are factored into the federal formula.

Q&A: Student loan co-signer repercussions

Dear Liz: I co-signed a student loan for my son. He was unemployed for a year and has now returned to work. The lender is not being cooperative with accepting a lesser monthly payment or any payment until he gives them a lump sum he does not have. They have been calling me about this debt. I am retired, 74, with a pension and Social Security as my sole income. I have no assets. What can they do to me?

Answer: If this were a federal loan, the government could take a chunk of your Social Security check and withhold your tax refunds. But your son also would have far more options for getting caught up, including a pathway out of default and income-based repayment plans.

Because it’s a private loan, evidenced by the fact it required a co-signer, the lender has fewer powers to collect, but you and your son also have fewer consumer protections. The Consumer Financial Protection Bureau recently released a report detailing people’s complaints about private lenders’ unwillingness to offer affordable payment options or modifications for unmanageable student loans.

That doesn’t mean your son should quit trying. The CFPB has a sample letter on its site that he can use to request a repayment plan he can afford. If he’s still having problems, he can make a complaint to the CFPB.

When you co-signed, you promised to pay if he couldn’t. Private collectors typically can’t take your retirement income, however. You may want to make an appointment with a bankruptcy attorney who can assess your situation. (Student loans, federal or private, typically can’t be discharged in bankruptcy, but the attorney will know the rules for creditors and borrowers in your state.) You and your son also should review the information about negotiating with private student lenders that you’ll find on the Student Loan Borrower Assistance site run by the National Consumer Law Center.

Q&A: Student loan forgiveness and taxes

Dear Liz: You recently wrote about student loan forgiveness. After 15 years as a public defender, my wife was diagnosed with multiple sclerosis and could no longer pursue her career as a lawyer. She applied for forgiveness of the federal student loans she used to attend law school. About three years later, the loans were forgiven. The caveat is that she was required to pay income taxes based on the balance that was erased. The taxes amounted to $63,000. Getting the loan forgiven was easy compared with coughing up the money for the IRS. I thought this should be mentioned.

Answer: The IRS generally considers forgiven or canceled debt as income to the borrower. There are several exceptions, however.

Borrowers don’t have to pay income taxes on student loans forgiven through programs that require them to work for a specific number of years in a certain profession. So public service loan forgiveness, law school repayment assistance, teacher loan forgiveness and the National Health Service Corps’ loan repayment program won’t trigger taxes. Forgiven debt also may be excluded from income if the borrower was insolvent at the time.

Student loan discharges for death, disability, closed schools, false certification and unpaid refunds typically are considered taxable income, however. Forgiveness of remaining balances under income-based repayment programs after 20 or 25 years of payment is also considered taxable.

The taxes owed will be a percentage of the amount forgiven, based on your tax bracket. If you’re in the 25% federal bracket, for example, you’d pay $25,000 for $100,000 of forgiven debt, plus any state and local income taxes. It’s less than the tab you owed, of course, but as you note it can still be a tough bill to pay.

Q&A: Disability and student loan liability

Dear Liz: My nephew was persuaded by a recruiter to attend a for-profit technical college. Then, once he entered, his “advisors” persuaded him to take many, many classes — at full price — always handing him student loan paperwork to get more loans. Then they persuaded him to change his major, necessitating a whole new round of classes and loans to pay for them.

The problem is my nephew has Klinefelter syndrome, a genetic disorder. He was not diagnosed until he was an adult and therefore was left with a mental age of about 12. This is what made him so gullible. He did graduate but in the six years since has not been able to find work because it is obvious to employers that he is mentally challenged. Now his training is becoming obsolete, making jobs even harder to get. This means there is no way he will ever be able to pay back the thousands of dollars in loans. Klinefelter is listed in the disabilities registers, but because he can function, any kind of aid is really hard to get. Do you have any advice on what to do about the looming debt?

Answer: The questionable tactics of some for-profit colleges have prompted regulatory investigations and lawsuits. That doesn’t mean the debt that affected students accumulated will be easy to erase.

Many for-profit colleges rely heavily on federal student loans for their funding. If your nephew’s loans are federal, he might be able to qualify for a total and permanent disability discharge of his federal loans, said Mark Kantrowitz, publisher of EdVisors, a college resource site.

“He will need a doctor to certify that his disability prevents him from obtaining gainful employment,” Kantrowitz said. “He will also need to earn less than the poverty line annually for the three-year post-discharge monitoring period.”
Kantrowitz has more information about such discharges on his site.
Another option is to consult an attorney, Kantrowitz said. “If he lacked the mental capacity to enter into a contract, he might be able to repudiate the loans,” Kantrowitz said.

Your nephew also may be able to discharge the loans in bankruptcy, Kantrowitz said. Typically student loans can’t be erased this way, but there are exceptions, including one woman in Maryland who was able to erase $340,000 in law school and other education debt after a judge said her Asperger’s syndrome made it impossible for her to hold a job.

“The odds of success are low, but many of the successful discharges involved disabilities, especially when the loan program did not provide for a disability discharge,” Kantrowitz said.

A final possibility, if your nephew has federal student loans, is to sign up for an income-based repayment program. If his adjusted gross income is less than 150% of the poverty line, his required payment would be zero and he would be eligible for the discharge of his debt after 25 years.

Q&A: Student loans and forgiveness

Dear Liz: I have a rather ugly student loan predicament. You mentioned “the possibility of forgiveness” in a recent column. I feel very strongly that I am deserving (if I dare use that word) of partial or full forgiveness of my undergraduate loans, although the loans from my graduate studies sting quite a bit too. I am not sure whom to contact to tell my story. Do I ask my lender, or do I contact the federal government education department? I get beyond frustrated talking to my lender, as they have employees who can only read from a script and can never help with particular issues.

Answer: You don’t win federal student loan forgiveness with an effective sob story. You get it by volunteering, working in a high-need area or following the relatively new rules for erasing remaining balances after many years of on-time payments. You also can get your federal (but not necessarily private) loans discharged if you’re totally and permanently disabled, you die or your school closes before you get your degree.

FinAid.org maintains a list of some of the forgiveness and stipend options available. People who teach full time in low-income districts, for example, can have up to $17,500 of their Stafford or PLUS loans forgiven under the National Defense Education Act. Forgiveness options exist for health workers and attorneys who serve high-need areas. Students in the Army National Guard may be eligible for its repayment program, which offers up to $10,000 for repaying student loans. AmeriCorps, the Peace Corps and Vista also have stipend programs for student debt repayment.

In addition, the federal Public Service Loan Forgiveness program promises any remaining federal student loan balances can be erased after 10 years of payments. Eligible public service jobs include employment with federal, state or local governments or not-for-profit organizations designated as tax-exempt by the IRS. You can find more information about this program at the U.S. Department of Education’s Federal Student Aid site.

Even if you work in the private sector, you can qualify for forgiveness after 20 to 25 years of on-time payments, depending on when you incurred the debt. Again, see the education department’s site for details.

If you’re finding your payments onerous, you may qualify for the “Pay as You Earn” or other federal income-based repayment plans. If you have private student loans, though, you have far fewer options and consumer protections. You may want to visit the Student Loan Borrower Assistance site run by the National Consumer Law Center to learn more about strategies for coping with this debt.

Q&A: Credit cards vs student debt. Which should be paid off first?

Dear Liz: I have $8,000 in savings. Should I use it to pay the accrued interest on federal student loans that go into repayment soon? Or should I pay credit card debts of $662 at 11.24%, $3,840 at 7.99% and $3,000 at 6.99%?

Answer: Pay off the credit card debt. The interest isn’t tax deductible, and balances you carry on credit cards just eat into your economic well-being.

Your student loans, by contrast, offer fixed rates, a wealth of consumer protections and tax-deductible interest. You needn’t be in any rush to pay them off, particularly if you’re not already saving adequately for retirement and for emergencies. Federal student loans offer the opportunity to reduce or suspend payment without damaging your credit scores should you face economic difficulty and the possibility of forgiveness. Those aren’t options offered by credit card issuers.

If your student loan payments exceed 10% of your income when you do go into repayment, you should investigate the federal government’s “Pay as You Earn” program, which offers more manageable payments for many people, especially those with large debts and small incomes.