A little more on student loans
Q: I read your article and it rang so true. My daughter will graduate this year with about $10k in loans in her name from Cal State, but we (her parents) owe tons more. I don't even look at the statements, but I think it is near $80k. The school offered a combination of loans and grants for my daughter and us. I read all the fine print and all the hoops they make you jump through, but basically, we will go broke 6 months after she graduates. Can you address the Parent Plus Loan situation as well?
A: I have been getting more mail on this topic than almost any other I’ve covered over the past three years. Paying for college seems to have touched a raw nerve for many people.
Parent PLUS loans are federal direct loans available to parents of dependent undergraduate students. They bear a fixed rate of interest and generally have a ten-year repayment term which can be modified under some circumstances. And although loan repayments are deferred until six months after the student graduates, interest accrues during the deferral period.
The interest rate for loans made during a particular academic year are set in June of that year at a spread of 4.60% over the 10-year U.S. Treasury yield. The interest rate for loans made in 2019-2020 academic year is 7.08%.
If you take out a Parent PLUS loan, you will pay an eye-popping 4.428% origination fee which is generally rolled into the loan balance. Including the origination fee, your effective interest rate will be 8.43%. To put this in perspective, parents who borrow $10,000 in Parent PLUS loans in the 2019-2020 academic year, will pay more than $21,000 in principal and interest by the time the loan is finally repaid in 2034.
Parent PLUS loans are easy to get (perhaps too easy) as long as the parents do not have an adverse credit history. The borrowing parent simply submits the “Free Application for Federal Student Aid” (FAFSA) and then contacts the financial aid office at the student’s college or university. The federal government sends the money directly to the school and the school then disburses the money into an account from which school expenses are paid. If there is money left over, it can be disbursed to the parent.
This nearly effortless way in which this debt builds up is one of the things I dislike most about student loans. Literally, all you have to do is check a box and the school will pay tuition and other school expenses for your child with new student loans. You need to be mindful that the financial aid office is not your friend. Its job is to figure out how to pay for school and that usually means a healthy dose of student loans. It does not worry about how much debt you can afford or if your student’s major justifies the borrowing.
What can you do if you find that you have overborrowed? Unfortunately, you are left with very few options. Student loans, including Parent PLUS loans, are very difficult and expensive to discharge through bankruptcy. If you want to try, you will need to declare bankruptcy first and then get an attorney to convince a judge that paying your student debt will impose an “undue hardship” on you and your dependents. The judge will have full discretion on interpreting what “undue hardship” means. Unless you have severe physical or mental disabilities and are living at a barebones standard of living, you probably have little chance of getting your student loans fully discharged. Also, if you stop making payments on your student loan, the government has the right to garnish your wages.
The best course of action is to get rid of that debt as soon as you can. You may want to work with a financial planner who can help you create a plan to pay it off. You might also want to find a copy of Dave Ramsey’s book “Total Money Makeover.” I’m a big fan.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.