Ask Liz Weston

Get smart with your money

College

Parents trapped by huge student loan debt

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Dear Liz: My husband and I took out more than $200,000 in federal parent PLUS loans to pay for our two daughters’ college educations. My husband earned over $300,000 when the loans were made. Since then, he lost his job and now makes $100,000. I went back to work and earn $35,000. We finally succeeded in getting a more affordable mortgage, but we are taking about $3,000 out of our savings each month to pay the bills.

My husband handles the finances and says that even if we could lower our loan payments, it wouldn’t matter because we still have to pay forever. He can’t even think about retiring. We do have a financial advisor, but I’m very concerned and wonder whether we should be using our savings this way. What are our options?

(P.S. Our girls both graduated, although one doesn’t have a great job and the other is still looking for work.)

Answer: Parent PLUS loans can, in moderation, help families pay for their children’s college educations. The key phrase there is “in moderation.” Even at your former income level, taking on so much debt for your children’s educations was ill-advised.

You don’t have a lot of options, unfortunately. As you probably know, this debt typically can’t be erased in Bankruptcy Court. If you stop paying, the government can take your federal and state tax refunds, garnish up to 15% of any Social Security benefit payments and ruin your credit, said Mark Kantrowitz, publisher of the FinAid and Fastweb financial aid sites.

“The government can also sue defaulted borrowers to recover the debt if they believe the borrower has sufficient funds to repay,” Kantrowitz said.

Ideally, you wouldn’t have borrowed more than you could have paid off before retirement (while still being able to contribute to your retirement savings). Since that’s not the case, your best strategy may be to simply get the payments as low as you can and resign yourself to paying this bill, perhaps until you die. (PLUS loans are canceled when the borrower dies and are not charged against the borrower’s estate, Kantrowitz said.)

As you suspect, it’s not a good idea to dip into savings to pay your monthly bills, especially when you’re doing so in the vague hope that things will get better rather than in the face of concrete evidence that they will.

There are several ways of stretching out the term of the loan to reduce your payments. One is using all available deferments and forbearances to suspend repayment for a few years. Then you could use an extended repayment plan to stretch out the loan term to 30 years.

Normally you wouldn’t want to take deferments and forbearances because interest continues to accrue, digging you into a deeper hole, Kantrowitz said. “But if the goal is to reduce the burden of the monthly payments and not ever fully repay the debt, it can be a workable strategy,” he said.

Another possible option for some families is an income-contingent repayment plan. Parent PLUS loans aren’t eligible for the more favorable income-based repayment plan, but income-contingent plans could lower your payments to 20% of your discretionary income, with the balance of the loans forgiven after 25 years of repayment. Discretionary income in this case is the amount of your income over the poverty line.

To qualify, you’d need to consolidate your Parental PLUS loans into a Direct Loan consolidation loan. You can find out more at http://www.loanconsolidation.ed.gov. Given your current income, though, you may be better off with the extended repayment plan.

 

Don’t buy an education you can’t afford

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Dear Liz: Please make me feel like I’m doing the right thing. My daughter happens to be very talented academically and athletically. She will graduate from one of the best prep schools in the country. She also plays ice hockey and is being recruited by some of the best schools. However, we are of middle-class means. We were given outstanding aid from her prep school, which made it very affordable. The net price calculators of the colleges recruiting her indicate we won’t get nearly the same level of support.

We have a lot of equity in our home and about $25,000 total in college funds for both of our children (we also have a son in 9th grade). We make about $185,000 as a family and pay about 12% to mandatory retirement and healthcare accounts. I’m hoping by some magical formula we can beat the “calculator” but I’m not so confident. So please tell me that paying for an elite education is worth our sacrifices. Our daughter has worked very hard to put herself in a position to gain entry into these schools, but I just need an expert to make me feel better.

Answer: An expert who makes you feel better about buying an education you can’t afford isn’t doing you any favors.

So let’s do a reality check. The amount you have saved for both your children would pay for a little more than one semester at most elite schools, which run around $60,000 a year these days. If she finishes in four years, that’s a price tag of about a quarter of a million dollars.

Of course, most college students don’t pay the sticker price for college. They get some kind of help. You, however, can’t expect much of that help, since you’re really not “of middle-class means.” At your current income, you make more money than about 95% of American households. Financial aid formulas don’t particularly care that you may live in an expensive area or that you prioritized spending over saving, only realizing too late that you can’t afford the schools your daughter wants to attend.

The exceptions may be Ivy League schools, many of which have committed to capping tuition costs even for upper-income families. If your daughter gets into one of those schools, she may have a shot at an affordable education.

Other schools may be willing to give her “merit aid” to induce her to attend, especially if she’s an outstanding hockey player and they want outstanding hockey players. But you’ll still be left with a sizable bill and only one way to pay for it: borrowing, either from your home equity or via federal student loans. Your daughter can borrow $5,500 in federal loans her first year, but as parents you can borrow up to the full cost of her education from the federal PLUS loan program.

Which leads to the question: Is taking on up to a quarter of a million dollars in debt for an undergraduate degree a sacrifice or is it insane? Before you answer, consider that some research shows that students who are accepted to elite schools, but attend elsewhere, do just as well in life as people who actually attend those elite schools. (The exceptions are kids from lower-income families, who actually do get a boost in life from attending elite schools. Obviously, that doesn’t include your child.)

Also consider how you’ll feel about making payments of $1,800 a month or so for the next 30 years to pay for this education. And how you’ll feel telling your son, “Sorry, kid, we spent all the money on your sister. You’re on your own.”

The picture may not be as grim as all that. You may get a better deal from one of these schools than you expect. But you should start managing your daughter’s expectations now and look for some colleges you can actually afford in case the dream schools don’t come through for her.

High incomes limit financial aid

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Dear Liz: As an avid reader for years I have never felt as compelled to write as I did after reading your column regarding college financing. I disagree that college financial aid is based primarily on income or that “typically [parents are required to] contribute less than 6% of eligible assets.”

We filed a Free Application for Federal Student Aid for our daughter, and our expected family contribution was calculated at $43,000. The school offered my daughter just $2,000 in work study, at a university with a $38,917 annual tuition. Our combined income is $175,000 and our liquid savings (not including retirement accounts) is $145,000.

We could pay 6% of our income (about $12,000) or 6% of income plus savings ($19,000) per year without taking loans, but not $38,000. I have attended several “paying for college” seminars and found their estimated contributions quite sugar-coated compared with the reality.

Rather than paying 6%, is the reality 25% of our income? Please let me know if we have done something wrong, and how to rectify it.

Answer: The 6% limit on eligible assets is not a cap on how much you’ll have to pay for college. As the original column said, income weighs more heavily in financial aid calculations than assets, and your income is high.

The federal financial aid formula assumes families with high earnings have more disposable income to pay for college than lower-earning families. The formula also assumes high-income families have had ample opportunities to save for college, whether or not they actually have.

You could use the net price calculator on the college’s website to see whether your liquid savings are having an effect on your expected family contribution. At some schools, using savings to pay down a mortgage or other debt could result in a lower expected contribution.

But you still might not get aid, even if you could move the needle on your expected contribution. Many colleges “gap” their students by not supplying enough aid to meet all their needs. And while some private colleges offer merit (rather than need-based) scholarships to attract the children of wealthier parents, top-tier schools tend not to, because they know they can attract excellent candidates without such help, said Lynn O’Shaughnessy, author of “The College Solution: A Guide for Everyone Looking for the Right School at the Right Price.”

Even if your family doesn’t have financial need according to the formula, your daughter is still eligible for federal student loans of as much as $5,500 in her freshman year. Federal student loans are flexible debt with fixed interest rates and many repayment options, so they shouldn’t be feared, especially in reasonable amounts. If, however, you would have to borrow much more, and that borrowing would interfere with your plans for retirement or other financial goals, you probably can’t afford this school and need to start looking for colleges you can afford.

Income matters more than assets in financial aid formulas

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Dear Liz: You write about it not being a good idea in many cases to pay off your mortgage, but does it make sense to do so to reduce savings so that we can be in a better position to help our high school junior get financial aid for college in a year? We also have a 529 and some investments and are savers.

Answer: Your income matters far more to financial aid calculations than your savings, said Lynn O’Shaughnessy, author of “The College Solution: A Guide for Everyone Looking for the Right School at the Right Price (2nd Edition).” Another important factor is how many children you have in college at the same time. If you have a high income and only one child in college, you may not get much or any help, regardless of how your assets are arranged.

Many schools ignore home equity when figuring financial need, however, so it might be worth running some numbers. You can do that by using the net price calculators included on every college website. Pick the schools your junior might want to attend and run two scenarios on each calculator: one with your current financial situation and another in which you’ve paid off your mortgage with your savings.

Many parents are overly worried about how their savings will affect potential aid, O’Shaughnessy said. Parental assets, including 529 accounts, receive favorable treatment in financial aid formulas. Your retirement assets aren’t included in the federal formula at all, and your non-retirement assets are somewhat shielded as well thanks to an “asset protection allowance.” The older you are, the more of an asset protection allowance you get. The allowance will be somewhere around $45,000 for a married couple in their late 40s, the typical age for college parents. For those over 65, the allowance is $71,000. Beyond that, you’re typically asked to contribute less than 6% of eligible assets toward your offspring’s education each year.

 

Now available: My new book!

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Do you have questions about money? Here’s a secret: we all do, and sometimes finding the right answers can be tough. My new book, “There Are No Dumb Questions About Money,” can make it easier for you to figure out your financial world.

I’ve taken your toughest questions about money and answered them in a clear, easy-to-read format. This book can help you manage your spending, improve your credit and find the best way to pay off debt. It can help you make the right choices when you’re investing, paying for your children’s education and prioritizing your financial goals. I’ve also tackled the difficult, emotional side of money: how to get on the same page with your partner, cope with spendthrift children (or parents!) and talk about end-of-life issues that can be so difficult to discuss. (And if you think your family is dysfunctional about money, read Chapter 5…you’ll either find answers to your problems, or be grateful that your situation isn’t as bad as some of the ones described there!)

Interested? You can buy this ebook on iTunes or on Amazon.

Co-signed loan burdens parent with student debt

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Dear Liz: I co-signed some private student loans for my youngest child. She graduated two years ago with about $80,000 in student debt, including federal and private loans. Like many other recent graduates, she has had a difficult time finding a job. She worked part time at a retail store until about a month ago and made around $7,000 annually. I have been helping her make reduced payments and she has gotten deferments and income-based repayment plans.

But I’m planning to retire in a few months and won’t be able to make the payments as I have been. I am heartsick about this whole situation, not just for my family, but also for thousands of young people who face this mountain of un-dischargeable debt. We desperately need some advice on how to deal with huge debt.

Answer: As you know, student loans typically can’t be shed in Bankruptcy Court. Even your Social Security benefits aren’t safe: In 2005, the U.S. Supreme Court upheld the government’s ability to offset Social Security disability and retirement benefits when a borrower has defaulted on federal student loans.

Income-based repayment plans can provide some relief with the federal loans. This repayment option limits the required payment to 15% of your daughter’s discretionary income, and her balance can be forgiven after 25 years, according to Mark Kantrowitz, publisher of the FinAid.org financial aid site. If your daughter has no income, her required payment would fall to zero. Unlike deferment and forbearance plans, which have three-year limits, the income-based repayment allows zero payments indefinitely. She should investigate signing up for such plans for all her federal loans.

The private loans you cosigned have far fewer repayment options. Some have forbearance and deferment options, while others do not. You may be able to negotiate a lower payment temporarily, or you may not. Because private student loans’ rates and terms aren’t regulated the same way federal loans’ are, they’re considered much riskier. Using them is kind of like paying for college with credit cards, except unlike with credit cards, the debt can’t be discharged.

It’s too late to tell you that you shouldn’t have co-signed loans so close to retirement or any time you would be unable to take over the payments. If you have sufficient equity in your home, you may want to consider using it to pay off the private loans. A variable-rate home equity line of credit would allow you to pay only interest for 10 years, while a fixed-rate home equity loan would lock in today’s current low rates for the 20-year life of the loan. You will, of course, be putting your home at risk if you can’t make those payments.

Another possibility is to postpone your retirement until your daughter is gainfully employed. This may not be desirable or even possible, but at the moment you’re the only one with income to repay these loans.

Otherwise, your option is to try to negotiate an affordable repayment plan with the private lenders, which is no easy task. For more information, visit the Student Loan Borrower Assistance program at http://www.studentloanborrowerassistance.org.