Some of the worst advice about paying for college involves the word “Don’t.” Examples of bad advice include, “don’t go to college,” “don’t save for college,” “don’t apply for financial aid” and “don’t repay your student loans.” This bad advice is especially problematic because it not only causes people to miss opportunities, but it is harmful and can interfere with their future success.
Anybody can express an opinion or call themselves an expert, but few people have the experience, knowledge and insights to help students and their families make smart decisions about paying for college.
Let’s consider some of the most pernicious advice provided by so-called pundits.
Bad Advice: You don’t need to go to college to be successful. Some of the nation’s wealthiest business leaders dropped out of college, including Bill Gates (Microsoft), Mark Zuckerberg (Facebook), Steve Jobs (Apple), Michael Dell (Dell), Jack Dorsey (Twitter), Paul Allen (Microsoft) and Larry Ellison (Oracle).
Reality: For every self-made billionaire who dropped out of college, there are thousands of college dropouts who are financial failures. The most reliable path to financial success is to graduate from college. College graduates have much higher average incomes and much lower unemployment rates than students who only graduate from high school.
Bad Advice: You will qualify for more financial aid if you don’t save for college. The financial aid formulas penalize parents who save for their children’s college education. College savings are also unlikely to grow enough to make a big dent in the ever-increasing cost of a college education. Why sacrifice other financial goals and priorities, why deprive your family of fun and enriching experiences, when the college is just going to take the college savings?
Reality: The penalty for saving is minimal, if you save in the parent’s name. Money saved in a 529 college savings plan owned by a dependent student or a dependent student’s custodial parent will be treated as though it is a parent asset on the Free Application for Federal Student Aid (FAFSA). If you save in the student’s name, financial aid formulas will reduce eligibility for need-based aid by 20 percent of the net worth of the assets. For example, each $10,000 saved in the student’s name will reduce aid eligibility by $2,000. But, if you save in the parent’s name, a portion of the parent net value of the assets are sheltered and the remaining reportable assets will reduce eligibility for need-based aid by at most 5.64 percent. For example, each $10,000 saved in the parent’s name will reduce aid eligibility by $564. That still leaves the family with $9,436 to pay for college costs.
Every dollar saved is about a dollar less borrowed, so saving for college can reduce debt at graduation. Every dollar borrowed will cost about two dollars by the time the debt is repaid. It is cheaper to save than to borrow. College savings also increases college choice, providing the student with the flexibility to choose a more expensive college than he or she could otherwise afford.
Bad Advice: There are many reasons why families don’t apply for financial aid. They say that they won’t qualify for need-based financial aid because they make too much money or have too many assets. They worry that applying for financial aid may affect their student’s chances of being admitted or reduce eligibility for other forms of financial aid.
Reality: The bottom line is you can’t get aid if you don’t apply.
Eligibility for financial aid is based on demonstrated financial need, the difference between the cost of attendance (COA) and the expected family contribution (EFC). Financial need can increase not just because of a lower EFC, but also because of a higher COA. So, a wealthy student might qualify for need-based financial aid if he/she attends a higher-cost college. Also, the EFC depends on the number of children in college. Increasing the number of children in college from one to two is like dividing the parent income in half, significantly increasing eligibility for need-based financial aid. Also, there are some forms of financial aid, such as the unsubsidized Federal Stafford loan and the Federal Parent PLUS loan that do not depend on demonstrated financial need. Even a billionaire can qualify for these loans.
Very few colleges have need-blind admissions policies, so applying for financial aid can potentially reduce the student’s chances of being admitted. But, most colleges will not subsequently award institutional grants to a student who did not initially apply for financial aid unless there has been a significant change in the family’s financial circumstances since the student first applied for admission. Colleges don’t like it when a family tries to game the system. It does the student no good to be admitted without the financial aid he or she needs to be able to afford to attend the college. Either the student will graduate with too much debt or the student will be forced to drop out of college for financial reasons.
Receipt of a private scholarship reduces the student’s demonstrated financial need. In turn, colleges will reduce the student’s need-based financial aid package. About a fifth of colleges will reduce their own grants first, yielding no change in the college’s net price. The net price is the difference between the college’s full cost of attendance and just gift aid (grants, scholarships and other money that does not need to be earned or repaid). But, the other colleges will use the private scholarship to replace need-based student employment and/or loans, reducing the net price. This form of award displacement helps reduce the student’s debt at graduation.
Bad Advice: The don’t worry approach to paying for college discourages students from planning how they will be able to repay their student loans. It tells the student to follow his or her passion and assumes that everything will work out ok in the end.
Reality: When you borrow money to pay for college, there’s a presumption that you will be able to get a job after graduation that pays well enough to repay the debt.
Education debt may be good debt because it is an investment in your future, but too much of a good thing can hurt you. Total student loan debt at graduation should be less than the borrower’s expected annual starting salary. If total debt is less than annual income, the borrower will be able to repay his or her student loans in ten years or less.
Otherwise, the student will struggle to repay his or her student loans. Students who graduate with too much debt tend to delay major life-cycle events, such as buying a car, getting married, buying a house, having children and saving for retirement. There are very few options for financial relief after college graduation. It is easier to reduce student loan debt before you incur it than afterward. Be responsible. Budget before you borrow.
Bad Advice: You don’t need to repay your student loans because loan forgiveness is imminent. In just a few months, UFOs will land in various cities throughout the United States and aliens will emerge to announce the cancellation of all student loan debt. The U.S. Department of Education will reluctantly agree to the demands of the Debt Collective and forgive all outstanding student loans without any byzantine paperwork requirements. Borrowers will be able to assert dissatisfaction with the quality of education, difficulty obtaining employment in the borrower’s field of study, dropping out of college and unwillingness to repay debt as defenses to repayment. Congress will pass legislation allowing student loans to be discharged in bankruptcy. The cost of these loan forgiveness programs will be covered by a new tax on the tooth fairy.
Reality: Defaulting on student loans will seriously damage your finances. Student loans are almost impossible to discharge in bankruptcy. There is no statute of limitations on federal student loans. Collection charges of up to 20 percent are deducted from each loan payment, slowing the repayment trajectory. Interest continues to accrue even after default, digging you into a deeper hole. The federal government has very strong powers to compel repayment of defaulted federal student loans, including wage garnishment, offset of federal and state income tax refunds and intercepting lottery winnings. After you retire, the federal government will take a portion of your Social Security retirement benefit payments. Your credit score will drop, making it more difficult to get a credit card, auto loan or mortgage. You won’t be able to obtain FHA and VA mortgages. You may even find it difficult to rent an apartment or get a job. Some states will block renewal of professional licenses and driver’s licenses. The federal government may sue you to place a levy on your bank accounts and a lien on your real property.
Defaulting on your federal student loans will not save you money. The monthly payment under wage garnishment is higher than the monthly payment under income-based repayment. Student loan settlements are almost always much higher than the loan balance at the time of default.
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