It drives me nuts when I see the financial media telling people partial, or half truths, and acting like it’s gospel. It drives me even more crazy to see that same bad advice parroted across a million podcasts, blog posts, and conversations.
So today, I’m hear to tell you to stop telling people they can’t get loans for retirement, but their kids can get loans for college. You’re wrong. This is a half truth that can lead you to giving – or receiving – some pretty poor advice.
Why Is This Wrong?
You might be taken aback by this. After all, you’ve probably read this advice in literally every personal finance book ever written. I talked about this a little bit in a prior post where I explained that colleges don’t give you aid if you don’t feel like saving. Today I’m going to expand on this subject with some cold hard facts.
You’ll hear variations on this as well – “put on your own financial lifejacket before helping others”, and there will be people who tell you that you can just opt to not save for college if you’re too far behind in retirement. And your kids can get get loans, loans, loans!
Believe it or not, the government considers it a parents responsibility to help their children with college. Yes, they will help out with some loans, but despite what you may have read, those loans are limited. You can only borrow a certain amount each year as a student, with an overall limit of up to $31k over five years.
Technically the student can borrow up to $5,500 the first year, $6,500 the second, and $7,500 for each subsequent year until they hit that $31k cap. You might find it interesting that the average debt is $30,100 per student for the seven out of ten people with loans graduating this year. Is the fact that it’s right under the limit a coincidence? Maybe.
You might notice that the limits are low compared to average tuition, room, and board at a typical college. It would cover community college, or part-time tuition only. It isn’t enough to even touch a private school, or pretty much all public four year schools (at least in my state they’re all above those amounts).
If students are limited to those amounts, how on earth do they afford to go to college? And how are so many graduating with massive loans? And why is it wrong to say that your kids can’t always get loans? Lets continue.
If the loan limits are so low, how are people going to college?
The key to this can be found in Sallie Mae’s “How America Pays For College” report. You can check out more here. The biggest bulk is scholarships and grants, but 36% of total costs are covered by parents – either through loans or payments from income and savings.
With this information you can see that students really only fund about 25% of overall cost (between income, savings, and borrowing). The other 75% is covered by their parents, relatives, and the college itself.
How are so many graduating with massive loans?
If these limits are so low, it explains the average loan amount of just under $31k total. But it doesn’t explain those people you read about in the media with $50k, $75k, $100k or more in student loans. How does that happen?
There are two primary reasons that people would have loans above $31k:
1 – Graduate degrees. The limits above are for undergraduates. People seeking a graduate degree can borrow at much higher amounts.
2 – Co-Signers. Private student loans require co-signers. A graduate might consider debt to be “theirs” when it’s really “ours” – it belongs to the student and the parent.
There’s a third way, and that’s if a student is considered to be independent of their parents. But that’s uncommon – it’s very difficult to be considered independent of your parents as a student. A parent refusing to pay for their kids college, or refusing to fill out the FAFSA, doesn’t make them independent. What it does is it wrecks that kids chance of going to college until they can pay for it themselves, or until they turn 24.
Why is it wrong to say that your kids can’t always get loans?
Now we get to the main point of this article – that it does people n injustice to keep parroting that same old line that your kids can get loans for college, but you can’t get loans for retirement.
As I mentioned, the government believes it’s a parents responsibility to pay for college. In order for your kids to be eligible for any loans, you have to complete the FAFSA – Free Application for Federal Student Aid. That form will measure your income and savings, and determine what your family is expected to contribute.
This means that if you earn a median income, or above, or have anything in savings above a small amount, the government and the college are going to expect you to contribute. Can you refuse? Sure. No ones going to grab your hand and force you to write a check. You can decide not to fill out the FAFSA too, but then your kids won’t be able to get any loans. You have to fill out the forms for them to be eligible.
If you’ve filled out the FAFSA, or done some research on paying for college, you may have heard this term before – Expected Family Contribution, or EFC. It’s how much you – yes you – are expected to shell out each year for college from current income and savings. The government expects you’re going to deplete about 5% of your assets each and every year for college, in addition to a significant chunk of your income. If you think about it, that’s an expectation you’ll spend 20% of your assets per child, plus your income.
And don’t think that they’re going to make you fork over a percentage of what you take home – oh no. If you’ve deducted, say, your 401k contributions from your income, those get added back into the equation. The government essentially assumes you’re going to stop saving for retirement while your kids are in school, and make sacrifices to pay out of your income. Families are often shocked and surprised at their EFC, and don’t know how they’re going to afford it. Even if you don’t have older kids, it’s worth looking at what your EFC would be today – check out this calculator. It might be eye opening to see what you’ll be expected to contribute.
If you look at the EFC and say “No way can I afford this!” do the colleges and the government just give you more money – or offer your student more favorable loans, or grants – to make up for it? Nope! But you, as the parent, can certainly take out your own loans. Or you can get some private loans to close the gap. Or your kids can just not go to college. Your choice.
Surprised to learn all of this, given that you’ve heard so often that old line about your kids easily getting loans? You didn’t really think that you could just spend/save whatever you wanted for yourself, did you? That people could drive around in new SUV’s, buy McMansions, and then make their kids take out loans for college because they “could never afford to save”? That the government would just say “Oh, you poor thing, here’s some free money for your kids to go to school?” or maybe “Don’t worry if you don’t want to spend money on college – you can just burden your kids with tens of thousands of dollars in loans, stunting their ability to buy a home/start a family?”
The Cold, Hard Truth
If you know someone who hasn’t saved a dime for retirement, and they have kids approaching college age, they may be forced to pay money out of their income or take out loans to pay for college. If they’re making a low income, they may be in luck – but if they’re making a good living, the government and college don’t care that they don’t actually have money set aside. And they don’t care if that person is behind on retirement. After all, they knew that they had kids, that those kids would one day go to college, and that college is expensive. And they presumably new they would want to retire one day. They should have been saving all along. There certainly is some element of “punishing” people who have saved, and “rewarding” people who spent all their money, but the spendthrifts don’t get off scott free.
One warning – The EFC can also come back to bite the early retiree, if they think they’re not paying for kids college. If you have substantial amounts in after-tax accounts, they’ll expect you to deplete that by 5% per year per child. So up to 40% of your assets will be gone if you have two kids. There are even some schools that use another equation that counts your home equity and retirement accounts as assets (called the CSS profile). So watch out.
The Key Takeaway
Go into your financial decisions with your eyes wide open, and don’t listen to the financial platitude that your kids can always just get loans for college.
Because they can’t.
Have you read that saying, that kids can always get loans for college but parents can’t get loans for retirement? Are you surprised to learn that it’s not true, and that kids can’t always just get loans for college? Let me know in the comments.
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