College continues to get more and more expensive: The average total cost at private colleges and universities topped the $40,000 mark during the 2013-14 academic year, according to the College Board. And given that tuition and fees are rising at a 3 percent to 4 percent clip annually, and have far outpaced both inflation and wage growth for many years, many families have had to resort to large student loans to cover the costs.
As a result, parents have to be smarter than ever about making sure they avoid what can be catastrophic financial mistakes. To help you make better decisions, here are four things that every parent should know about student loan debt.
1. Co-Signers Are on the Hook for Student Loan Debt
The recent story of Steve and Darnelle Mason shows the dangers of cosigning a student loan. The Masons cosigned about $100,000 in private student loans that their daughter Lisa took out to go to nursing school. When Lisa died of liver failure at age 27, the Masons suddenly found themselves the target of lenders seeking repayment for Lisa's loans, and interest and late fees sent the total outstanding balance above $200,000.
Media attention to the Masons' situation prompted at least one lender to reduce the interest rates and principal balances on the loans. But most people don't fully realize the potential liability involved in cosigning a student loan until a tragedy like this occurs.
2. It Matters Who's Borrowing the Money
Financial aid calculations assume that both students and their parents will make contributions toward educational costs. Accordingly, the financial aid packages that your child receives might include loans for both students and their parents. Just as with a cosigner on a private loan, whether the parent or the student is the legal borrower on a loan is a key consideration in who's ultimately responsible for repaying it.
A willingness to be flexible with who's taking out a loan can give you better terms. For instance, Parent PLUS loans offer features like reasonable fixed interest rates and options for delayed repayment, as well as simplified credit checks that can make parents more likely to qualify than if they worked with a private lender. But the overarching factor needs to be whether parents can repay loans in a worst-case scenario, and the more debt parents take in their own name, the more financially exposed they'll be if things don't work out as well as they hope for their child.
3. Know the Forgiveness Terms for Your Child's Student Loans
The Masons' story is just one example of how important it is to know the terms of a student loan. Different types of loans have different features that can make it easier or harder to repay under certain circumstances.
For instance, most federal student loans -- including Direct Loans, Federal Family Education Loan Program Loans, and Perkins Loans -- are automatically discharged in full if the student dies. For parents who take out federal PLUS loans, then either your death or the death of the student can lead to the loan being treated as repaid in full. Other situations can also lead to partial or full repayment, including permanent disability, forced closure of the school you were attending, and employment as a teacher or in certain other public-service jobs.
By contrast, private loans almost universally have less generous forgiveness or deferment rules. As with other forms of consumer credit, including credit card debt and auto loans, lenders have wide latitude in setting the terms of their private student loans, and they have no incentive to offer forgiveness for policy reasons in the same way that the federal government does. However, as private businesses, lenders often assess whether a given private student loan is uncollectible, and if they decide that offering a modification is more likely to get them a larger recovery than trying to enforce the original terms of the loan, then they'll make that business decision.
4. The Best Debt Is No Debt
Given the high and ever-rising costs of tuition, room and board and other expenses, it will remain a huge challenge for most families to finance a college education without loans. Nevertheless, if you can start investing cash for that purpose early (in a 529 Plan, a Coverdell account, or some other more potent growth tool than a bank account), even small amounts of savings can add up to a substantial balance by the time your child starts college. By doing so, you can take a big step toward offsetting what would otherwise be larger loan balances for your child to face.
Knowing more about student loans doesn't mean that they will be easier to repay. But by being aware of some of the pitfalls, you can at least take steps to reduce the chance of any nasty surprises that could crush your financial future.
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"We're living in the 'now' generation, with kids wanting everything now and a lot of parents giving in," says Dan White, a certified financial planner with Dan White and Associates in Glenn Mills, Pennsylvania. But there's a difference between simply wanting the shiny new thing because it's out there and desperately needing the shiny new thing because not having it has larger consequences in your teen's mind.
"Sometimes teens feel that if they don't have the latest and greatest gadget, they won't be popular or fit in," says Kimberly Foss, a certified financial planner and president of Empyrion Wealth Management in Roseville, California. "This is reflective of a deeper issue of self-worth and self-esteem."
The prevention: Foss recommends asking in a calm, non-emotional environment about the reasons they made the purchases and listening to the response and watching the body language. Counseling may be in order if you feel your teen is compensating for a bigger emotional issue, Foss says.
If it's just a case of your teen wanting the next newest thing, White recommends establishing an allowance and saying no to your kids when they ask for more.
According to a recent Gallup Poll, 68 percent of American adults do not have a detailed monthly household budget. Kids who don't see their parents paying attention to the family's inflows and outflows are going to have to cram in later life to learn those important lessons -- in real time, with their own real money.
The prevention: Kids should learn the concept of budgeting for life's expenses before they go to college, advises Ric Runestad, owner of Runestad Financial in Fort Wayne, Indiana. Establish your own budget and share it with your kids. Have your children make their own budget for things like vacations and summer camp.
"The odds of winning the lottery is somewhere around 1 in 259 million," says Gregg Murset, a certified financial planner and CEO of MyJobChart.com in Scottsdale, Arizona. "If your child thinks this is a good way to plan for the future, just start planning now to have them living with you during your retirement."
The prevention: Make sure you're quickly correcting your kids whenever they mention a lottery ticket or windfall. (Search "odds of winning the lottery" for even more colorful examples.) Explain the importance of saving and working hard to fulfill their future dreams.
It's one thing if your child asks to borrow a few dollars to buy something and pays it back immediately when you get home. "However, if a child starts to treat their parents as a payday loan service, then the parents should act as a payday loan service by charging expensive rates of interest," Runestad says.
The prevention: Reinforce the "If you want it now, you have to pay for it now" behavior by instituting a realistic interest rate on borrowed money. Take a cue from the credit card industry and set it around 15 percent. Run the math with your child and show how much more an item costs in the long run when it is paid for with borrowed dollars.
Does your child assume (unrealistically) that he or she will replicate your lifestyle when it's time to be on their own? Here, again, there may be a communication breakdown. "It's important for parents to assess their own behavior and guide the child in the right financial direction," says Eric Johnson, principal of Signature, a wealth management advisor in Charlottesville, Virginia. "If they're spending lavishly and telling their children to save, there will be a large disconnect in the child being able to form solid monetary values on their own."
The prevention: Talk early and often about your money values and reinforce the idea that your wealth may not be a signal of your child's future lifestyle.
"Children can be every bit as gullible as adults when it comes to trying to help someone out who really is just taking advantage of them," says Runestad. "Everyone wants to be liked, and we all have times we need someone to lend us some money. However, any time money is lent it should be under very stringent requirements."
The prevention: You can't always know about your child's private financial dealings. But you can instill in them standard expectations when it comes to money issues by consistently following certain money rules when they come up at home. So, when you lend money to your child, remind them that you are not in the debt forgiveness business and you expect full repayment of the loan by a certain date. Consider drawing up a standard fill-in-the-blank lending document for all parties to sign.
"While piggy banks can be a cute way for a youngster to learn about nickels and dimes, what purpose do they serve after that?" asks Murset. "If your kids are old enough to earn money, they're old enough for their own bank account."
The prevention: Open a bank account with your child, walk them through the process of making deposits, teach them about online banking and earning interest. There's no better education about the adult world of finances than actual hands-on experience with the products they'll be using for the rest of their lives.
"Some kids think that credit cards represent free money that banks give away for people to buy things," says Murset. "Until your children have a clear understanding of how cash advances work and what interest rates, penalties and fees mean, they shouldn't have one."
The prevention: Teach your kids the difference between a debit card and a credit card as you use them. When they are old enough, get them a pre-paid credit card. Fund it with their allowance or savings, and give them room to make their own mistakes (such as running out of money because they weren't keeping track of the balance). Better that they learn the lessons of proper plastic usage under your watch.
If your kids spend more time watching TV or playing video games than helping around the house, they're not developing a sense of responsibility, says Murset.
"Get your children off the couch and out of their rooms to do their share around the house," he says. "Besides building a daily routine, they'll develop a good work ethic."
The prevention: Not all chores should be equated with payment. Helping around the house is simply part of what family members do. However, certain chores and work above and beyond the basics can be linked to extra payments. As your kids develop a work ethic, they'll start to learn that doing a good job and taking on more work can be satifying both financially and emotionally.
"Young adults are made to believe that once they graduate college they'll be able to pay off their student loans quickly," says White. "That couldn't be further from the truth. An average student takes a minimum of 10 years to pay off an undergraduate degree."
The prevention: Together, as a family, go over all of the costs of higher education -- everything from tuition to room and board, meals, gas money, and airplane tickets home for the holidays. Together, discuss ways to cut costs. And make sure your kids are exploring every opportunity and avenue for covering college expenses before they commit to a large loan, says White.