You want your child to go to a good college. That is the number 1 item on your list. There’s just one problem.
College is really expensive.
Just how expensive is it?
The average cost for an in-state public school is $9,970 for the 2017–18 school year. If your child decides to go to an out-of-state school, the cost balloons to $25,620.
What about a private college? That comes to $34,740.
That’s scary on its own, but let’s dig a little bit deeper.
On average, parents have saved a mere $18,000 for college.
That’s about half what they need if their kids go to an in-state school.
Around 35 percent of parents haven’t saved anything at all.
Are you getting stressed yet? Well, it gets even worse when you look at the borrowing patterns many families follow.
When kids don’t have the money to pay for college, they typically look into student loans. “No big deal,” they think. “I’ll just borrow what I need and pay it back when I get that super-high-paying job as an artist.”
As you can imagine, those payments are hard to make, and it’s just expected to get worse. The default rate is expected to get close to 40 percent by 2023, making it clear that students are taking out way more than they can afford.
But that’s just part of the issue.
Students also can’t borrow all they need.
Most parents don’t realize that the government sets borrowing limits on college students. These limits change depending on the year the student is in.
For the first year, dependent students can’t borrow more than $5,500, and it goes up by a thousand dollars the next two years. It stays at $7,500 for the fourth year and beyond, as well.
There’s a catch, though. That’s the combined borrowing limit for subsidized and unsubsidized loans. During the first year of college, students can only take out $3,500 in subsidized loans, and that goes up by $1,000 the next two years.
("Subsidized loans" means the government pays the interest while your child is in college. "Unsubsidized loans" means the interest is added to the principal balance while you are in school....so if you borrow $30k, by the time you graduate you already owe quite a bit more!). Guess which path most choose? Yep, they add the interest to the balance.
That means the rest must be taken out in unsubsidized loans.
Students might end up turning to private loans to fund the rest of their college, but those loans are much more expensive. Plus, they are more difficult to get -and later, refinance.
This is where the second part of the debt cycle comes into play.
As a parent, you want to save the day. You want to make sure your child goes to college, and you feel guilty or inadequate because you don’t have the money he or she needs.
That’s why you’ve thought about doing what should be unthinkable.
You’re considering taking out a Parent PLUS loan.
These loans are a huge mistake for so many reasons. First, there is the obvious reason that you will be taking on student debt as you get close to retirement. There are horror stories about parents trying to retire while owing six figures in Parent PLUS loans. Even five figures in Parent PLUS loans can prevent you from retiring.
Think of it this way. If you can’t afford the debt today, you cannot afford it when you retire. That means you’ll likely have to keep working to make those minimum payments for the lifetime of the loan. Lots of parents end up taking the loan out for 25 years, so that will put you a long way from retirement. That’s practically a mortgage, and you won’t even get your own degree out of it.
The only other option is to default on the loans, and that is an even bigger problem.
Getting into debt isn’t the only issue with these loans. They are much more expensive than other types of loans, so you will end up owing a lot more than you borrow.
At 7.6 percent interest, the interest rate is quite a bit higher than the 5.05 percent rate for direct subsidized loans. Plus, Parent PLUS loans are unsubsidized, so the interest kicks in right away. That means you will have to pay interest for the entire life of the loan.
The origination fee is also an issue. It’s 4.248 percent for PLUS loans and only 1.062 for direct subsidized loans. That’s a huge difference.
You would think that numbers like this would keep parents away from Parent PLUS loans, but that’s hardly the case. In fact, right now, 3.4 million people have Parent PLUS loans, owing $81.5 billion dollars. Yes, that is billion with a “B.”
You have to pass a credit check to get a Parent PLUS loan. Those who don’t pass the check often do something that’s even worse.
They take out home equity loans to pay for college.
They basically borrow against their homes to pay for college.
There are a couple of problems with this. First, when you take the equity out of your home, you never know what could happen. If property values decline, you can be in serious trouble.
Plus, if have to relocate, you won’t have the money in your home anymore. You’ll basically just have to pay it off when you sell it, and then you’ll start from scratch somewhere else. That’s not what you want to do this close to retirement.
You also have to consider that the government has eliminated the tax deductions people used to get on home equity loans. That means you’ll end up paying back more now that you would have years ago.
Parent PLUS and home equity loans are not the solution to your problem. Instead, you need to think smart when sending your child to college.
Look at other options for college. Send your child to a community college or have your child work at a company that offers tuition reimbursement. Your child can also take a gap year while saving for school.
Those are all excellent options if your child is about to leave for college. If you still have time, sign up for a financial planning workshop to get help saving for college.
I'm a personal finance geek. A real estate investor. An accountant, a single mother. And I'm going to get my kids through college without student debt! Will you?