Take control of college debt
Two-thirds of students borrow to pay for college. One in 10 have loans of $35,000 or more. Do you have to go broke to get a B.A.? Not with these moves you don't.
(Money Magazine) -- When Jessica Barba was deciding where to go to college, she didn't factor how much she'd have to borrow into the equation.
She knew that her parents could afford to contribute only a few thousand dollars and that she'd have to make up the rest. But all the Virginia native could think about was how much she wanted to live in New York City.
"I was 17 years old," says Barba, now 26. "The idea of going to school in New York seemed like the coolest thing in the world."
So when Barba got the nod from New York University, she accepted - even though she'd have to take out more than $100,000 in loans over four years to pay for it. Even though she'd have had to borrow only half as much if she'd gone to the University of Chicago or Pittsburgh's Carnegie Mellon, where she was also accepted. But neither school was in New York. And at 17, "the difference between $50,000 and $100,000 didn't register," she says. "It all seemed like a lot of money."
Exactly how much sank in soon after Barba graduated in 2001. Working at a nonprofit, Barba took home $1,800 a month - not nearly enough to cover loan payments of $900 a month while paying for food, clothing and rent on a New York City apartment.
Her parents had to step in. Currently they're shelling out $2,000 a month to pay off loans and grad school bills for Jessica and her two younger brothers.
Says John Barba, 59, a school psychologist in Oakton, Va. who drives his late dad's 13-year-old Buick and watches his expenses closely: "It's a drain - like having a second mortgage."
Welcome to the new reality of paying for college - and the crushing debt that often accompanies it. With tuition rising more than twice as fast as inflation and grants shrinking as a share of the financial aid pie, more and more students feel forced to borrow ever larger amounts to pursue their college dreams.
From 1993 to 2004, the median federal loan for new graduates jumped 63 percent to more than $16,000. One in 10 students at private college owe more than $40,000. And that's not even counting how much Mom and Dad borrow to help pay the bills.
The potential consequences are stark. The same debt that enables your child to attend the school of his dreams can lower your family's standard of living for years and divert money from critical goals like saving for retirement.
Students suffer too. According to one study, graduates burdened with student loans are far more likely than nonborrowers to live paycheck to paycheck, run up credit-card debt, postpone buying a house and even delay having children. Nor is there any easy way to make the debt go away: Except in rare cases, even bankruptcy will not rid you of a student loan.
Still, there are measures you can take to keep college debt from overwhelming family finances - both yours and your child's. Here's how to get a handle on it.
Before you borrow
With college planning, as with SATs and final exams, preparation is everything. Take these steps before taking out loans.
Factor price into the decision It sounds obvious: Every dollar less that a school costs you is one dollar less that your family has to borrow. Yet scores of debt-laden grads have the same sorry tale to tell about how they got into this mess - they chose to go to the best school that accepted them, regardless of price, and figured they'd work out how to pay for it somehow.
Don't let your kid become one of them.
Instead, make sure the schools she applies to represent a good cross section, varying in price as well as academic rating. That means putting a few good in-state and out-of-state public colleges on the list.
And look for other ways to keep costs down. Encourage your child to apply to at least one school where her SAT scores and grades will be relatively high, giving her a better shot at merit aid (to see how generous a school can be, go to its profile at collegeboard.com and find its typical "non-need-based" award).
Or she could start off at a lower-cost college and, if her grades are good enough, transfer midway to the pricier school of her dreams.
When Chad Sinclair, 20, realized he'd have to borrow $23,000 to finance his sophomore year at the University of Maryland, he instead spent a semester at Indiana's DePauw University, where he'd qualified for big grants that cut his loan to $2,500. After lobbying Maryland for more aid, he returned to the school the following semester, bringing his less expensive DePauw credits with him.
Set some limits A $10,000 loan to pay for your child's freshman year may seem manageable. But put that loan in context: Your child will be in school for at least four years, tuition will undoubtedly rise, and you may have one or two younger kids headed for college as well.
Remember, you've got a life too. "Don't sacrifice your retirement to borrow for your kids' education," says Rick Darvis, co-founder of the National Institute of Certified College Planners. "You can't borrow for your retirement."
So pace yourself. Get a handle on how much college debt you can realistically afford at FinAid (finaid.org/calculators). Or consult a financial planner who specializes in college financing (for referrals, go to niccp.com).
Help your child to be similarly hard-nosed about how much debt she can handle. If she's going to borrow more than her starting salary is likely to be, you know she's headed for trouble.
Says Paula Luff, director of financial aid at DePaul University in Chicago: "An aspiring social worker shouldn't take on $50,000 in debt."
Let your child borrow first Even if you intend to foot the bill for loans yourself, your child should borrow in his own name first (you can always help with the payments later).
The reason is simple: Federally guaranteed student loans are the cheapest higher education loans around. The most common kind is a Stafford Loan, available to all borrowers regardless of income, with a current maximum fixed rate of 6.8 percent. Your child can currently borrow up to $2,625 his freshman year under the Stafford program, a maximum that rises to $5,500 when he's a junior (or a total of $23,000 over five years as an undergraduate).
Unless the school your child attends dispenses Stafford Loans directly, shop among lenders for the best deal. Discounts generally come in two varieties: up-front breaks, such as waived initial fees, and those your child has to earn, such as interest-rate reductions for maintaining on-time payments.
If your child is the type who can't remember Tuesday morning where he left the car keys Monday night, he's probably better off with a lender that offers discounts with no conditions; college lender MyRichUncle (myrichuncle.com), for example, recently cut its post-graduation rate to a no-strings 5.8 percent.
Give yourself a plus Need more money than you can get from a Stafford? Your next best bet is probably a federal loan for parents, known as a PLUS loan. Depending on the school, you'll be charged either 7.9 percent or 8.5 percent, plus up-front fees, and you can borrow as much as you need to fill in gaps in financial aid.
And like Staffords, PLUS loans have fixed rates, which protects you against rising interest rates. By contrast, private education loans, which can be taken out by student or parent, typically have variable rates, and those can range widely depending on the credit rating of the borrower. Advertised rates often sound competitive with PLUS loans but in practice can go up to 12 percent or even higher.
If you've built up substantial equity in your home, you might also consider a home-equity line of credit. With rates recently averaging 8.2 percent, HELOCs are competitive with PLUS loans; both also allow you to deduct at least some of the interest you pay. But rates on a HELOC are variable, so your payments could rise sharply if interest rates generally increase. And of course, you're putting your home at risk. Proceed with caution.
When it's payback time
There are no quick fixes to make student loans magically disappear once you've borrowed the money. But these moves can make the payments more manageable and reduce the overall amount owed.
Pay early and often If your child has taken out a loan that rewards her for being a model borrower, make sure she lives up to her end of the bargain. Paying on time, month in and month out, can save thousands of dollars in interest over the life of the loan. The easiest way to keep a streak of timely payments going is to set up an automatic electronic funds transfer; just setting up the EFT is often enough to knock a quarter point off a Stafford's interest rate.
Once your child lands a job, encourage him to direct part of any raise to making higher loan payments instead of blowing the extra money on pizza and beer. He won't feel a pinch, since he'll still get to pocket some of his extra income. And he'll save on interest by shortening the life of the loan. Not to worry: Student loans typically have no prepayment penalties.
Let Uncle Sam help You and your child may be able to deduct as much as $2,500 of the annual interest you pay on your loans. You can claim the full write-off if your annual income is $105,000 or less and you and your spouse file jointly; or take a partial deduction if you make less than $135,000 (the limits are $50,000 and $65,000, respectively, for single filers).
You don't have to itemize to claim the break, and the savings can be substantial: up to $1,875 added up over five years if you're in the 15 percent bracket, and as much as $3,500 if you're in the 28 percent bracket.
Home-equity borrowers get a break too: You can deduct the interest on loans as large as $100,000. But you do have to itemize to claim this write-off.
Seek forgiveness If your newly minted grad is interested in a career stint in public service, he may be able to get at least a portion of his student loan forgiven.
In one program, for example, teachers who commit to working for two years in schools serving low-income communities can get a $4,725 annual grant that can be used to pay off student loans. Programs also exist for doctors and nurses who agree to work in areas that don't have enough medical practitioners; lawyers who pursue public-service careers or work for nonprofits; medical researchers; and those who agree to join the National Guard.
You can find a list of such programs at FinAid (finaid.org/loans/forgiveness.phtml).
Take a time-out If your child hits a rough patch - she has trouble finding a job, say, or is laid off from the one she has she can request a temporary halt to her loan payments. This kind of hiatus is known as loan deferment or forbearance, and it enables a graduate to skip payments for months at a time.
The bad news is that interest will likely continue to accrue on her loan. The deferment may count as a break in her on-time payment streak. The good news is that it will help her maintain a good credit rating.
Change the terms If your child's struggles can't be resolved in a few months, he can lower his monthly payments by extending the length of the loan. Stretching the payments from 10 years to 20 by consolidating $23,000 in loans, for example, would cut monthly payments by 34 percent from $265 to $176, assuming a 6.8 percent interest rate. Parents can use the same strategy for PLUS loans.
But stretching out payments is a step that should be taken only after careful consideration. Depending on the terms of the original loan, you could lose your on-time payment credits and have to repay previously waived fees. You'd also end up paying more in interest over the long run.
"I'm a firm believer in getting it over with as quickly as possible," says Eileen O'Leary, director of student aid and finance at Stonehill College in Easton, Mass. "Lives get complicated. You have children. Bad things happen. You get sick. The more of the loan you can get rid of up front before those complications set in, the better off you are in the long run."
Ultimately, though, the single best thing that you can do about student debt is to start thinking about it ahead of time. Typically, parents don't register the magnitude of their family's student loans until a child's junior year of college, says Nancy Ziering of Madison Financial Aid Consultants. "Going into debt to pay for an education," she says, "has to be done with a very specific plan to get out of it."
Ace your class, save some cash Good grades can mean a smaller tuition bill, lower insurance premiums and less rent.