Before a commercial flight leaves the ground, flight attendants instruct passengers to "Put on your...
Helping Adult Children Financially: Part 2 - Education Expenses
Helping With Student Loans
Student loans are a necessary evil for many who seek a higher education degree. As noted in 5 Reasons Your Adult Children May Need Help Financially, current student loan indebtedness stands at $1.77 trillion with an average monthly payment of $503, which the typical borrower will pay for 20 years.
Most recently, because of the COVID-19 pandemic, the federal government paused loan payments and set interest rates to 0% for eligible federal student loans from March 13, 2020, until September 1, 2023, with payments resuming October 1, 2023. As a result, many parents are inclined to help reduce the pain of student loans for their adult children in three ways:
- Helping to pay off student loans
- Taking out a parent loan
First, it’s important to understand the types of student loans. The two basic loan categories are federal and private loans.
Federal loans are subdivided into four types:
Subsidized loans – Such loans are for undergraduate students demonstrating financial need, which is determined by comparing expected educational costs versus how much the student’s family can pay. These loans typically have the best terms compared to other student loan types. One significant advantage is that the federal government will pay interest payments while the student is in school and six months after graduation.
Unsubsidized loans – This loan type differs from a subsidized loan because it is available to undergrad, graduate, and professional students, and there is no requirement to demonstrate financial need. Undergrads pay about the same rates as subsidized loans but are responsible for all interest payments.
PLUS loans – PLUS loans can be taken out by graduate or professional students (Grad PLUS Loans) or by the parents of dependent undergrad students (Parent PLUS Loans.) The amount that can be borrowed depends on educational costs and how much financial aid the students receive. PLUS loans require a credit check, but a bad credit score may only result in a cosigner requirement.
Consolidation loans – These loans roll the indebtedness of multiple federal student loans into one fixed-interest rate loan. While there are no fees to consolidate, borrowers may pay higher interest and lose advantages like loan forgiveness or cancellation eligibility.
Private student loans are available through multiple sources, most commonly banks and credit unions. Private loans require credit checks and generally have higher rates and more fees than federal loans. Most private loans require a cosigner since students rarely have high enough credit scores.
Private loan lenders often have stricter rules than those for federal loans. For example, loan forgiveness or postponement are usually not available. Also, while such loans cannot be combined into a federal consolidation loan, refinancing in the private market may be an alternative.
As noted above, cosigning is a way parents can help with student loans. Even if a cosigner is not required, it may result in a lower interest rate due to a cosigner’s superior credit history. However, cosigning means the cosigner is on the hook if the student fails to pay the loan. The borrower and the cosigner must clearly understand this fact before agreeing to proceed.
Another route a parent can take is to help the student make loan payments. Here are some things to consider:
Can You Afford to Help? – At the outset, it’s important to honestly assess your ability to help with payments without jeopardizing your financial health. Sacrificing your retirement savings or putting off paying your own high-interest debt can be risky. The best strategy is to organize your finances to maintain fiscal stability and help with whatever funds are left over.
Be Smart About Making Payments – Make sure the way you pay is both efficient and effective. Consider setting up automatic payments from your bank account so none are missed. Also, biweekly payments might be more effective than monthly payments. For example, if a monthly $400 payment is instead paid $200 every two weeks, the loan will be retired sooner.
Make Payments Before Graduation – Many student loans do not require payments to start until after a six-month grace period post-graduation. However, loan interest accrues from day one of the loan, thereby adding to the total amount due for repayment. A parent making payments before the end of the grace period can reduce the total debt the student will face when post-grace period payments start.
Match Your Student’s Payments – A great way to share the payment burden is to match your adult child’s monthly payment. (You could even alternate biweekly payments to pay off the loan faster, as noted in #2 above.) This could motivate the student to pay more than the minimum each month.
Help With Non-Loan Expenses – Helping with other expenses like groceries or a cell phone can free up funds for the student to make loan payments
Loan Payments as Gifts – Consider making loan payments as holiday or birthday gifts. Also, if a parent receives a windfall like a work bonus or unexpectedly high tax refund, these funds could be directed to loan payoff without jeopardizing the parent’s regular financial obligations.
Refinancing/Consolidation – If the student has federal loans, a consolidation loan might help. If refinancing private loans is an option, a parent could cosign, thereby reducing the interest rate and helping to make payments.
Parent Loan – One of the most profound commitments a parent can make is to take out a parent student loan. According to Sallie Mae, a public corporation that handles private student loans, about one-fifth of parents borrow to pay education expenses. The federal loan option noted above is the Parent PLUS loan. There are also private parent student loans. Other alternatives are home equity loans and borrowing from a 401(k). To re-emphasize the point made in #1 above, parents need to carefully analyze their ability to help adult children. Taking on long-term debt cannot be made without careful forethought. It might be better to simply help the student make payments rather than shoulder the legal obligation of a loan contract.
As a final note for parents helping with loan payments, be aware of the gift tax rules mentioned in Helping Adult Children Financially: The Basics. Whereas payments made directly to an institution for tuition are excluded from gift tax calculations, student loan payments are not. The only exception is if the lender is the school itself. Consult a CPA or a tax professional to determine how your payments will be treated.
Paying for Grandchildren’s Education
One way parents can support their adult children on the education front is to provide funds for grandchildren’s education. The assumption is that adult children's finances are freed up by helping with grandkids’ education expenses.
Ideas for doing this are:
Set up a 529 for grandchildren – As noted above, there are no restrictions on who can set up a 529 plan for a given beneficiary.
Paying for Preschool – Funds for preschool tuition are excluded from gift tax calculations. This applies only to preschools qualifying as bona fide educational institutions, not typical daycare providers. On the other hand, if a grandparent’s annual contribution to preschool or daycare is under $17,000 for 2023, then no gift tax paperwork is required.
Helping with Student Loans – If grandkids are college-age, most of the ideas noted in the section above apply to grandparents who want to help pay or cosign for student loans.
Helping to pay for education is one of the most satisfying ways a parent can help their adult children get ahead in life. However, it needs to be done with eyes wide open to all the options available and the implications for the parents' finances to ensure the best decisions for both student and parent.