How Parents Can Avoid Crushing Student Loan Debt
Trimming the cost of a Parent PLUS loan or a loan you co-signed
Student loan debt continues to grow rapidly, with more than $1.2 trillion outstanding. While much has been written about the impact that this debt will have on graduating students, parents are not immune from the burden. Fortunately, there are ways for them to avoid crushing student loan debt.
Parents can end up with student loan liabilities directly and indirectly.
The direct student loan liability for a parent: borrowing to help finance your child’s education by taking out a Parent PLUS loan. It’s more expensive than a student loan (the current interest rate is 6.84 percent) and a Parent PLUS loan comes with a hefty disbursement fee, currently set at 4.272 percent. The standard repayment term is 10 years, but graduated and extended repayment options are available.
You have the option to defer payment until up to six months after your child has graduated. However, interest accrues during the deferment period. That’s why, at a minimum, you should try to make the interest payments while your child is in college.
The indirect student loan liability for a parent: co-signing for a child’s federal or private student loan. From a credit perspective, co-signing has the same impact as borrowing directly. Many lenders will use the co-signed student loan repayments in the parent’s debt burden or affordability calculation, making it difficult for the parent to qualify for mortgage refinancing or other types of borrowing. In retirement, when income is likely lower than when you were working full-time, co-signed debt can make it particularly hard to get new credit because your debt burden will appear very high.
Here’s how to keep Parent PLUS loans and co-signing from breaking your bank:
Parent PLUS Loans
If you have a Parent PLUS loan and are having difficulties making the monthly payments, you can take advantage of one of the federal government’s income-driven repayment programs. These programs cap the parent’s monthly payment as a percentage of discretionary income, which is typically a maximum of 20 percent. You can use the government’s online Repayment Estimator to determine your maximum monthly payment. Income-driven repayment plans should be viewed as insurance against potentially lower earnings in the future.
An income-driven repayment program can be a great way to reduce your monthly payment for the remainder of your retirement, because any remaining balance would be forgiven upon your death.
One catch: To get an income-driven repayment program, you need to first consolidate your PLUS loans. To do that, just call your loan servicer and say that you want to consolidate and take advantage of the income-driven options.
If you can afford your PLUS loan payments, but just want to get rid of the debt faster, there are options to refinance at much lower rates. Just be cautious. If you refinance, you will give up certain federal benefits, including the ability to take advantage of income-driven plans in the future.
SoFi, a market leader in student loan refinancing, also lets parents refinance Parent PLUS loans with fixed rates as low as 3.50 percent and variable rates starting at 2.14 percent; there’s no origination fee. Two other lenders offering Parent PLUS refinance options: CommonBond and Earnest, which also offer fixed rates as low as 3.50 percent and variable rates starting at 2.14 percent and 2.13 percent respectively.
To make sure you get the best deal, it makes sense to apply to all of them online and shop for the lowest rate.
Since co-signing a student loan means you become liable for repayment if your child stops making payments and missed payments can ding your credit, you should be proactive in working with your son or daughter to help eliminate the debt as quickly as possible. You’ll also want to protect yourself. Here’s how:
First, be sure you check the lender’s co-signer rules and aim to remove yourself from the loan as quickly as you can. You might be able to release yourself from the loan after a certain number of on-time payments are made.
If the lender gives you trouble getting yourself removed as a co-signer, consider complaining to the federal Consumer Financial Protection Bureau (CFPB). The CFPB has a good track record of helping people in this situation.
You might also want to insure your student loan liability against the unlikely death of your child. If your son or daughter dies, the student loan debt would pass to you as the co-signer. An easy and low-cost way to eliminate this risk is buying a term life insurance policy on your child for the loan amount.
If your child is having difficulties making payments, income-driven repayment options might be available from the federal government. Such options are even more generous than for Parent PLUS loans. The monthly payment would be capped as a percentage of discretionary income, with most loans eligible for a cap of 10 to 15 percent of discretionary income.
Your child will have to handle the process, but you can learn about it at the Department of Education website.
And a tip to help your child reduce your co-signed student loan payments — if he or she has a good job and income, suggest refinancing the debt. The interest rate would be very low. As noted above, variable rates for refinancing student loans lately have been as little as 2.13 (variable rate) and 3.50 percent (fixed).
Refinancing private student loans makes a lot of sense. Refinancing federal loans is riskier, because you forfeit income-driven repayment options, so for these, it only makes sense if your child has an excellent job, an emergency savings fund and a high level of confidence that he or she will be able to pay off the debt.
Because of the increased competition among lenders, your child should shop around for the best refinancing deals by checking rate-comparison sites (full disclosure: the MagnifyMoney site that I co-founded is one of them). It’s best if your child qualifies to refinance on his or her own, so you won’t be on the hook anymore.