When parents co-sign with their children for a student loan, no one is thinking about how they will repay it. Each party is looking to a successful future; graduation, jobs, spouses, grandchildren and so on. Parents need to keep in mind and act on two points before signing or co-signing a loan to get their child started; especially if they are applying for a Private Student Loan. If Federal Student Loans are not an option to you, you should proceed with your private student loans with caution.
First, nearly half of all students entering college as freshmen will not leave with a degree. They dropout, get kicked out, or find another career path that doesn’t require a four year degree. Second, even if a student does graduate, finding a decent paying job let alone an actual career prospect is still a slim chance compared to ten years ago. Unless that student walks into their dream job right after graduation; parents need to understand now that they will be paying at least part of this loan in the near future.
To avoid or at least deal with this unpleasant possibility before it happens, parents need to talk to their children before entering college about repaying their loan. If it is too late for that, they need to speak to them as far in advance of graduation as they can. Both parties need to know exactly what to expect in order to avoid defaulting on their loan and ruining the credit of everyone.
If the worst does happen, parents need to heed the words of Liz Weston, a financial counselor – “Retirement savings has to be a top priority, so that’s just a given and everything else has to fit in around that.” Parents have to remember that their children are the ones benefiting from a student loan. They have 40 years or more before it’s time to retire and can handle dealing with the loans better than someone who is looking to retire in just 10-15 years. This is not the time for parents to cash out their 401(k) s and cover for their kids in order to ‘help them out’. Student Loan Forgiveness could be option later on if Federal Loans were taken rather than Private.
The first step needs to be negotiating with the loan lender. No loan officer is going smile and say ‘Just pay us what you can’, but they will be open to lowering the interest rates or adjusting other terms of the loan. Sending a loan in default to a collection agency or writing it off completely isn’t good for the bank’s bottom line just like it isn’t good for the borrower’s credit rating.
If negotiation fails, the next step is to find a cheaper loan. A second mortgage or home equity loans have some of the lowest interest rates available. These loans normally have a 15 year term and the rates are fixed. A benefit to using a home equity loan is that the payments are tax deductible if the borrower itemizes on their tax returns.
There are drawbacks on a home equity loan. It cannot be made until a large portion of the first mortgage has already been paid off or an applicant already owns their home outright. Also, a home equity loan means the parents now have a lot more to lose. Mark Kantrowitz of the National Foundation for Credit Counseling put it very succinctly: “If you default on a private loan, the worst thing they can do is garnish your wages. If you default on a home equity loan, the worst they can do is take your home.”
The next, less attractive option is to take out a HELOC, a Home Equity Line Of Credit. Similar to a home equity loan, the interest rates on a HELOC are variable. This means the bank can raise the monthly payment irregardless if they have all been made on time and without interruption. Even with improvements in the housing market, HELOCs are still difficult to get due to much lower housing values compared to a decade ago.
Finally, parents can tap into their retirement accounts. 401(k) s can be a source of tax free income, but it’s a very short period of time. Any money taken out has to be replaced within five years, with interest. Most of these privately controlled plans allow for no more than half of the balance or $50,000 in total to be withdrawn at any point. IRAs are heavily taxed for early withdraws by the IRS as well.
The only good option to repaying a private loan is to make regular, monthly payments that are within a graduate’s budget. Unfortunately, that option is out of reach for a lot of graduates and their parents at this time. For those parents who have not taken out a loan yet, they need to sit down and speak very frankly with their children on what a student loan is going to mean to their future and the impact it can have on the entire family. Student Debt Relief can help families with these tough decisions.