A reader trying to help her son 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 and so I am trying to help him to 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 loan, and Sallie Mae has a lower rate than the ParentPlus but am not sure what to do. SoFi advertises great rates so that’s another option.
What do you think?
Student Loan Shopping Basics
Based upon the well thought out questions in this email, 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, it is critical that you answer the “should I borrow 14k” question before you answer 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 any money is borrowed, it is essential to make sure you can afraid the payments before you get the loan(s).
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 the amount that can be borrowed by undergraduate students, families often find themselves in the same shoes as our reader.
If you do find you have to borrower additional money, the question than 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 mom and dad’s credit won’t be impacted for what could be decades. Like 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 giant interest rate.
Option 2: Only the parent signs
By having just a parent sign for the loans, there are a couple advantages. First, what a parent with an established job and credit history can qualify for is entirely different than an unemployed college student. Second, the advantage for the student is if they hope to buy a house in the near future, having the loans on someone else’s credit report is a huge advantage.
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 (in the event 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, there are some protections built-in that offer assurances that private loans can’t match.
If the parent can definitely afford the student loan repayment should the need arise, finding the lowest interest loan on the private market could save the most money in the long run. 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 are also signed on the loan. One downside to having two people on the loan is that it will appear on both credit reports and could potentially limit the ability to borrow in the future. This is a major 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 when it comes to 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 been known to engage 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 actually require the balance of the loan to be immediately paid back in full. Moral of the story: read the fine print on the loans before you sign, and have backup plans in place in case the unexpected does happen.
The Best Approach
While the cost of attendance and family finances vary greatly from situation to situation, there are a couple steps that should be taken in every family.
Make finding a student loan a collaborative effort.
Just having the student pick out a loan 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 just 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 value of a dollar, or 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. A student who understands the consequences of their college spending will be far more likely to be frugal and take out less debt. Plus, if they ever do have to take out an additional loan, they will be careful to find the one with the best interest rate.
From a parent perspective, if you want your child to be responsible about their debt, tell them if they don’t pay off the interest each month, you won’t sign for future loans.
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 normally 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 the fact 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 not a decision to be taken lightly. 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 that will be 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 a number of different lenders so that applicants can fill out one application and see the actual rates offered by many lenders.
Putting everything together, there are three basic questions that must be taken 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?
One Final Tip
Colleges do a great job of presenting options to pay for school and making sure 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 it comes to selecting the best route to pay for school.