How Parents Are Contributing to the Student Debt Crisis
Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article do not represent financial advice.
“Student debt” should be renamed “school debt”, just like how “global warming” changed to “climate change”. The current naming convention places a disproportionate focus on the role “students” play in the debt crisis. This is a problem because several factors that determine whether a child will need to consider taking on debt are completely out of the student’s control, such as the parents’ income, spending habits, and education outlook.
Naysayers need look no further than the FAFSA formula, which determines eligibility for financial aid. It calculates that parents will contribute 22–47% (range depends on number of dependent family members) of their net income and 5.64% of their non-protected assets toward their child’s education.
The higher a parents’ income and non-protected assets, the lower a student’s chances of getting aid.
If parents have high enough income and non-protected assets to make a child ineligible for aid, then doesn’t that raise questions about the parents’ spending habits over the last 18 years? If they don’t set money aside for their child’s education, how do parents expect that children will pay for college? Parents range from being very hands on to having a laissez-faire mentality regarding college selection, but regardless what the outlook is, it will influence their child’s decision of where to go to school.
Therefore, parent’s play a pivotal role in contributing to the student debt crisis, and articles like this, which try to pin the blame on students, are infuriating.
HOW CAN PARENTS FINANCIALLY CONTRIBUTE TO A STUDENT’S EDUCATION?
Education Savings Account
In an ideal scenario, parents set up an education savings account, like a 529 Plan, when their child is young. They should estimate how much annual tuition will cost when their child matriculates, and consciously determined what percentage of total tuition they are capable of saving.
This is important because, as SallieMae identified in a 2018 report, “parents with a plan have double the savings.”
The SallieMae report also discovered that 4 in 10 parents are not saving for college at all, and identified four “saving-for-college” personality types. I assume that the “uncertain” persona, defined by its likelihood to purchase big-ticket items without a plan or budget, and “dispassionate” persona, defined by its apathy toward college, comprise a large portion of the 40% of parents who are not saving at all. I find these two personas concerning because children of such parents will likely have an unhealthy relationship with money, which is no fault of their own. Rather than chastise these children, educators and thoughts leaders should find ways to equip these future students with the knowledge necessary to make sound financial decisions despite the absence of college savings.
401K Retirement Loans
Articles like this, which inform parents “your child can always borrow to pay for college, but you can’t borrow for your retirement,” provide incomplete information. Generally, there is a 10% penalty for distributions from a traditional or Roth IRA before age 59 ½, but there is an exception for qualified higher education expenses.
This means parents can borrow up to half of their vested 401K balance, or $50,000, whichever is less, without incurring the 10% penalty.
The interest rate on the loan will be a point or two above the prime rate, and the current prime rate is 4.75%. Tax implications should be considered, but for some individuals it may be more economical to pay that interest back to yourself rather than to a federal or private lender.
Pay the Interest While in Deferment
Not having to make payments while enrolled may sound like a relief, but it is a wolf in sheep’s clothing. One of the worst things that can happen is for the interest to accrue on unsubsidized loans while a student is in school, just to be compounded at the end of the graduate’s grace period. The reason that is bad is because, for example, a student who took out an unsubsidized loan for $40,000 (at 5.5% for 15 years) for their freshman year at a private university will incur $170 of interest every month, adding up to $8,000 of interest on just one loan by the time he/she graduates. If that $8,000 is not paid off before the grace period ends, then it will be added to the loan balance and lead the borrower to pay $70 more per month than they otherwise would have on that one loan, and $3,500 more in total interest.
Therefore, parents and students should consider paying at least the interest on all unsubsidized loans while the school loan is in deferment.
WHAT ARE NON-FINANCIAL WAYS PARENTS CAN SUPPORT THEIR CHILD’S EDUCATION?
Talk about the Education Return on Investment
The ultimate purpose of education is to make a living, and there is a measurable correlation between an education and an income. Unfortunately, simply getting an education is not enough — where you study and what you major in has an influence on expected earning potential. My alma mater, Georgetown University, researched the economic value of college majors and identified the highest and lowest paying majors. Whether or not parents expect to pay for college, it behooves them to set baseline expectations about their child’s anticipated major and career plans. As Dr. Anthony P. Carnevale explains, business majors can earn as much as $3.4M more over the course of their careers than people with liberal arts majors like Psychology, Art, or History. In order to improve their earning potential, graduates with lower paying majors would need to demonstrate exceptional performance or pursue graduate degrees.
That does not mean people should not pursue liberal arts majors, especially if it aligns with their passions and interests, but it does beg the question: does it make sense to pay tuition of $54,000 per year at a private university, like Georgetown, if a student does not expect their future income to reasonably exceed the tuition investment?
This question is relevant even for parents who have the capacity to pay for an education in full. Personally, I do not believe a negative ROI is worthwhile, but it is up to children and parents to have an open conversation about the child’s interests and decide for themselves.
Be Open to Lesser Known Schools For Undergrad
I have shared this story with friends and it seems to resonate most with children of immigrant parents: even though I received a full-ride to a university that ranked in the 50’s for the U.S national university rankings, my highly-educated immigrant parents advised me to take on debt so that I could attend another school which ranked in the 20’s. A friend, whose parents immigrated from India, gave up a scholarship from a school that ranked in the 60’s but his parents paid in full for him to attend a school that ranked in the 20’s. I do not believe either set of parents provided sound financial advice, especially considering that graduate degrees are becoming more essential in today’s work environment.
If a graduate degree is in the plans, then it is especially important to account for that financial decision and avoid breaking the bank for undergrad.
Consider Taking a Gap Year
The cost of college is too steep to be taken lightly. As mentioned earlier, the ultimate purpose of education is to make a living, but paradoxically, many 17 year old’s have not been provided with the experiences necessary to find their ikigai — which the Japanese say is found at the intersection of what a person is good at, what a person loves, what the world needs, and what a person can be paid for. People like Professor William Damon from Stanford University have recognized that “purpose endows a person with joy in good times and resilience in hard times,” which is essential for economic prosperity and minimizing the risk of burnout.
Therefore, rather than immediately enrolling in a costly university program, a high school graduate may benefit from taking a gap year to search for their “ikigai,” and then enroll in a degree that best aligns with their purpose.
BUT WAIT, SHOULDN’T STUDENT’S CONTRIBUTE TO THEIR EDUCATION?
Parents play an important role in setting an example about financial readiness but children should be asked to contribute to their education as well, especially considering the astronomical rate of tuition inflation. Students have traditionally known they should seek scholarships by studying hard and participating in extracurriculars, but it has been difficult to identify which activities universities value more than others. When I was in high school, I convinced my highly-educated immigrant parents that it was worthwhile to take time away from studying so that I could be captain of my basketball team, softball team, and mock-trial team, but I had no way of knowing how that would translate to dollar figures.
Fortunately, innovative companies like RaiseMe are introducing a much-needed level of transparency into the scholarship process.
They have partnered with hundreds of universities across the countries, like University of Chicago, so students can quantify the potential financial impact of each achievement. Students can register for RaiseMe as early as 9th grade.
While in college, students can seek some form of part-time employment. However, when you consider that the average tuition and fees over the past 20 years have jumped 154% at private universities, 181% at out-of-state public universities, and 221% at in-state public universities, even the hardest working student will likely graduate with debt. Additionally, part-time work has the potential of negatively influencing GPA performance, which can have a ripple effect on employment prospects. Internships that are resume-worthy are ideal but are not always easy to come by.
“Student debt” is a misnomer because parents play a very important role in the process. The FAFSA formula, which determines eligibility for financial aid, accounts for parents’ income and non-protected assets, and the rate of tuition inflation makes it nearly impossible for any student to graduate without debt if their parents do not provide assistance. Parents who are not able to provide financial assistance can still play an important function by talking with their child about the expected education return on investment, consider a range of potential education institutions, and entertain the idea of a gap year before diving into a costly investment. Nevertheless, students also have several ways they can contribute to ameliorating their debt burden. Companies like RaiseMe are introducing an innovative level of transparency into the scholarship process, and students can register as early as 9th grade. While in university, a resume-worthy paid internship is ideal because it can help a student both pay down the accruing interest on their loans and improve their experience and future earning potential.
If you have any questions about the information in this article please email me at FiscalHappiness@gmail.com
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