Avoiding College Loan Traps

Many older parents jeopardize their retirement when they don’t understand how college loan programs work.

By Ed Prince

More older adults are dealing with a challenge seldom encountered by earlier generations: They’re nearing retirement but helping their children pay for the enormous burden of today’s college education.

“Two things are happening,” said Fred Amrein, founder of PayForEd, which offers software to help students and parents navigate student loans. “People are having their children later in life, and … parents are now taking on the debt. People over the age of 50 are the fastest-growing student debt borrowers. And what we’re seeing are people making that decision because it’s an emotional decision for their children and family.”

Without proper consideration and planning, parents can get themselves into serious financial difficulty by taking on debt to pay for their children’s education, cautioned James Brewer, CFP, the CEO of Chicago-based Envision Wealth Management. Brewer also holds the College Funding and Student Loan Advisor (CFLSA) designation offered by Amrein’s PayforEd.

Nuts and bolts

Brewer and Amrein focused on the pros and cons of the federal Parent PLUS loan program during a recent webinar.

The Parent PLUS program is available only to parents and legal guardians. Loan repayment is expected to begin once the loan has been disbursed, although deferment can be arranged with repayment beginning after the student graduates. However, interest accrues during the deferment period.

Parent PLUS loans are part of the federal Direct PLUS program, which also includes loans for graduate students. This is separate from the federal loan program for undergraduate students. Holders of federal student loans and Direct loans have been excused from making payments since March 2020. That pandemic pause in the federal loan program is scheduled to end in September, when interest accrual resumes, and payments are to restart in October.

Direct PLUS loans have higher interest rates (currently 8.05%)  than private loans. While Direct PLUS loans offer greater repayment flexibility and options for loan forgiveness than private loans, they don’t offer as many options as other federal student loans, Brewer said. One option is Income Dependent Repayment, which is available for both student and Parent Plus loans and allows those struggling to repay to reduce their monthly payments.

The Supreme Court in June struck down the Biden administration’s student loan forgiveness program, which had included relief for some holders of Parent PLUS loans. But more help may be on the way. Shortly after the Supreme Court’s decision, the Biden administration announced a new $39 billion initiative for student loan forgiveness, which includes Parent PLUS loans.

While that plan may also face legal challenges and Supreme Court review, another longstanding initiative, Public Service Loan Forgiveness, remains in effect, allowing those in qualifying public service jobs to achieve loan forgiveness after 10 years of repayment.

Pros and cons

Parents who choose a lower-interest private loan rather than Parent PLUS, or refinance the federal loan to a private one to get the lower rate, can end up regretting the decision if they experience a financial setback like losing their job, Brewer said.“That’s when people suddenly start calling and asking, ‘What are my options?’” he said, noting that outside the federal program, there are few options.

In addition to relief options like PSLF and premium adjustments, the federal loans also offer disability and life insurance protections that allow discharge of a loan in the event that a parent becomes disabled or the if parent or student dies.But participating in the Parent PLUS program also has risks. For those in default, the federal government can withhold 15% of an individual’s Social Security payment and garnish tax refunds, Brewer noted.

Another potential pitfall can occur when a borrower uses the Income Dependent Repayment option to lower their monthly payment. If the repayment amount is less than the amount of accruing interest, negative amortization will result in a steadily increasing loan balance, Brewer noted.

He and Amrein maintained that individuals with federal student loans and Parent PLUS loans cannot expect sound advice from loan servicers, tax preparers or ordinary financial advisors, because that requires an informed, holistic approach that those professionals cannot provide.

Know the rules

“Knowing the rules, you can lower your repayment as you go into retirement to maximize your quality of life and your time,” Amrein said.

For example, although negative amortization normally would be considered a disastrous outcome of setting too low a repayment level, it can be advantageous for someone in the Public Service Loan Forgiveness program. That’s because for an individual with a qualifying public service job, such as a teacher, the student loan or Parent PLUS loan is forgiven after 10 years, or 120 on-time payments. Setting the payment as low as possible can result in savings of tens of thousands of dollars, Amrein and Brewer said.

Similarly, going against the advice of a tax preparer who recommends filing income taxes as married filing jointly, and instead opting for married filing separately, can yield big savings for an individual with a Public Service Loan Forgiveness option. By filing separately and shifting finances such as retirement savings contributions between the spouses, the couple would see an increase in income taxes but realize a far larger reduction in the loan repayment amount.

You can’t pass the buck

Brewer said the father one of his clients took out a Parent PLUS loan and later told his son that he could not afford it, and it was up to the son to repay the loan. A daughter received the same message. However, under the terms of Parent PLUS, a parent cannot transfer responsibility for the loan to a child or any other individual.

Rather than taking out a Parent PLUS loan and finding out too late that it’s not appropriate, parents should sit down with their children before college to map out a strategy, Brewer said. Oftentimes, part of the answer is to select an affordable college rather than the student’s dream school, he said.

Additional Reading: What Tuition-Paying Parents Stand to Lose

“The problem (occurs) when somebody says, ‘Beyond the package that the school was offering, beyond the student loans, there’s still a contribution that the parents need to come to the table with,’” Brewer said. “Well, maybe I really can’t afford that. The conversation needs to happen at the time that child is selecting their undergraduate (school), rather than, ‘OK, now I’ve got these loans; now, what do we do?’”

How advisors can help

An important role for an advisor of a client with a Parent PLUS loan is helping them to see the big picture, including what their retirement wants and needs — such as the cost of healthcare in old age — will be, and planning accordingly, Brewer said.“My mom … in September will be 95 and one of my grade school chum’s moms is 105. We didn’t think that we would hit these numbers, and they both have their complete faculties. No, they don’t have dementia. So, you just never know.”

In a four-decade career in journalism, Ed Prince has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune.

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