Tax Tip of the Week | Should a Parent or Student Take Out the College Loan?

Tax Tip of the WeekOctober 10, 2018 Per Forbes (June 13, 2018) who quoted Make Lemonade, “there are more than 44 million borrowers who collectively owe $1.5 trillion in student loan debt in the U.S. alone.” These numbers equate to about one in every four American adults who are paying off student loan debt. Many of our clients are fighting this fight. I hope some of you find this article helpful.“MANY FAMILIES plan to borrow money to pay for college. But some aren’t sure who should take out the loans – the parents or the student.Considering that 42% of families borrowed money to help pay for college in the 2016-17 academic year, according to Sallie Mae’s “How America Pays for College 2017,” this is a decision that many people will face. More students take out loans than parents, but there is no set formula for making the determination. It is largely a personal choice, based on a family’s preferences and financial circumstances experts say, and the approach could change from year to year.For those wrestling with the decision, here are a few things to consider:1.    TAP FEDERAL STUDENT LOANS FIRSTStudents generally should exhaust their federal student-loan eligibility before looking at other options, experts say. That’s because the interest rate on federal student loans is fixed regardless of a student’s credit history (or lack thereof), a cosigner isn’t required, and these loans are typically less expensive than a federal parent Plus loan or private student loans, says Debra Chromy, president of the Education Finance Council, a national trade association representing nonprofit and state-based higher-education finance organizations.Federal student loans come with other benefits, such as the ability to apply for an income-driven repayment plan, in which loan payments are based on a percentage of the borrower’s discretionary income and family size. Some federal student loans may even be forgiven and discharged under certain circumstances. People who work for the government, at qualifying nonprofits or in teaching, for example, may qualify for loan forgiveness.The problem is, students may not be able to cover the cost of college with federally backed student loans because there are limits on how much they can borrow annually and in total. (The limits depend on the student’s year in school and whether he or she is considered a dependent.)If federal student loans won’t fully cover the cost of school (and a student has exhausted scholarship and grant opportunities), it may be appropriate to consider other types of loans. The first step is to decide how much responsibility a parent is willing – and able – to take on.2.    EVALUATE PARENTAL EARNINGS POWERNot all parents are in a position to take on debt for their children – even if they would ideally like to cover all of their student’s education expenses. And if parents can’t afford to take on college debt they shouldn’t experts say, especially if it is going to take away from their retirement savings. While students have many other ways to pay for college, the same isn’t true of parents trying to save for retirement. And if parents eat up all their retirement money on education costs, they may be forced into the uncomfortable position of having to rely on their children for financial help later on in life.“If you’re taking the loan as a parent only, you have to feel comfortable that you are paying it off with your earning power,” says Joe DePaulo, co-founder and chief executive of College Ave Student Loans, a private student-loan provider.For parents who are comfortable taking on debt for college, here are a few options:◊ Federal Direct Plus loan for parents. With this option, parents can borrow money from the U.S. Education Department to cover any costs not covered by the student’s financial-aid package, up to the full cost of attendance. Parents generally need to start making payments as soon as the loan is fully disbursed, but they may request a deferment while their child is in school and for an additional six months after the student graduates; interest still accrues during this time. A Direct Plus loan made to a parent cannot be transferred to a child. Also, the interest rate may be considerably higher than some private options and there is an origination fee that comes off the top; that fee is 4.248% for loans between Oct. 1, 2018 and Sept. 30, 2019. Under certain conditions, a parent may be eligible to have part of the loan forgiven or discharged.◊ Home equity.   Parents may be able to take out a secured loan, such as a home-equity line of credit or home-equity loan, to pay education costs. With a home-equity line of credit, borrowers withdraw money as they need it, up to a certain amount. These loans often have a floating interest rate, and borrowers generally have 10 to 20 years to pay the money back. A home-equity loan, by contrast, is a one-time lump-sum loan that often comes with a fixed interest rate. The interest rates on home loans may be more favorable than other types of loans, but parents need to consider factors such as their home's value, how much they owe, how much they need and whether they are comfortable putting up their home as collateral before proceeding, experts say.◊ Private parent loans. Private lenders such as Sallie Mae and College Ave Student Loans offer private student loans for parents. Typically, these loans are available to people with strong credit histories. Borrowers may be able to choose between a variable or fixed rate and determine a repayment option that works for them. On the downside, these loans could be more expensive than other alternatives, says Charlie Javice, chief executive of Frank Financial Aid, a company that assists families in the financial-aid process.3.    CONSIDER SHARING RESPONSIBILITYStudents also have the option of taking on private student loans, which may be offered by state-based agencies, public companies, marketplace lenders or banks. Students generally can borrow up to their cost of attendance.These kinds of loans usually require a cosigner – often the parent – because most college-age students don’t have the necessary credit history to obtain a loan on their own. With a cosigned loan, payment history – good and bad – will affect the credit record of both people on the loan.Parents who cosign a private student loan need to consider the possibility that the child could be delinquent or default, Ms. Javice says. This can be a long-term concern since borrowers typically have about 10 years or more to pay off these loans. Several years out of school a child could lose a job, become an addict, go through a divorce or be unable to pay for some other reason, and the parent will be on the hook, Ms. Javice says. In some cases, the loan could become a stain on the parents’ credit record, which might affect their ability to borrow money to buy a home or a car, she says.For some parents, the desire to encourage fiscal independence and responsible financial behavior in their children outweighs the fear that they could end up on the hook for the child’s debt.They want their child named on the loan in the belief it will motivate the student to do well in school, finish on time and even spend the money more responsibly, says Mr. DePaulo of College Ave Student Loans. There are also parents who plan to cover the debt on the student’s behalf, but prefer the loan be in their child’s name to start the child’s credit history out on the right foot, he says.There’s no hard and fast rule about which type of private loan – parent or student – will be the least expensive or most beneficial. Different loans have different rates, perks and requirements, so families should shop around and compare how the various options stack up, says Ms. Chromy of the Education Finance Council.Families “should explore all their options so that they can make an informed choice that best reflects their needs,” she says.”Credit given to Cheryl Winokur MunkWall Street JournalMonday, July 9, 2018Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.This week's author - Mark Bradstreet, CPA--until next week.