Parents' Tough Choices For Repaying Student Loans

Talk to kids and lenders before raiding retirement savings or risking your home.


Earning a college education is a big financial risk, not just to the students working toward the sheepskin, but often to their parents as well. That's doubly true as the proportion of students financing their college years with loans rises, and many turn to private loans to pay for expenses that federal loans won't cover.

To offer their best student loan terms, most lenders require students to list a separate cosigner--a party who is legally on the hook to repay the loan in the event that the student doesn't. All too often, that cosigner is mom or dad, fast approaching retirement age and with a plethora of their own financial obligations.


Donna Martin, a 52 year-old city clerk in Victorville, Calif., faced the prospect of either cosigning for her daughter Jessica's $20,000 private loan three years ago or subjecting her offspring to heftier payments down the road. The elder Martin cosigned, and Jessica began working toward her psychology degree at nearby California State University, San Bernardino, where she is now studying part-time.

Meanwhile, even with a cosigner on the documents, the lender offered a variable interest rate that is currently at 7.65%. That, coupled with deferring payments, has sent the balance the Martins eventually must pay back to $28,000. With the loan balance rising, and the job market in the dumps, Donna is becoming increasingly fretful.

"I'm afraid that I will be stuck with this debt deep into retirement," she says.

Assuming the worst case comes to pass, and Jessica leaves school unable to repay her loan in full, her mother will face some very tough choices. Following are some guidelines for parents who find themselves in similar situations.

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Negotiate with your child. Launching a career is never easy, and that's especially so at a time when the job market is lousy and many starting salaries barely cover living expenses.

Still, it's important that parents begin early to manage a child's expectations regarding what is expected in terms of repaying a student loan for which they're both on the hook. First off, it's important to keep in mind that the child will be the primary beneficiary of the loan and will have four decades to pay it off before having to cover retirement expenses--a luxury parents don't have.

So start out by making it clear: Are you planning to repay the loan yourself or do you expect your child to cover all or part of it? Also make clear, possibly in writing, what sort of financial sacrifices and contributions you expect your child to make to repay the loan once they're out of school. And since half of entering college freshmen never graduate, make it clear as well what you expect if your child leaves school with debt, but no degree.

Negotiate with the lender. If you and your child are facing difficulty making student loan payments, call the lender, explain the situation and ask them to ease the terms. No, they're not likely to cut interest charges to zero or reduce the principal balance, but they may well be willing to share your pain.

"Lenders don't want to have to write things off," says Ted Beck, the president and CEO of the National Endowment for Financial Education, a nonprofit organization that focuses on personal finance.

Take out a home equity loan or second mortgage. Not all debt is created equally, and at least in terms of interest charges, loans that use a home as collateral tend to be among the least expensive.

Martin owns the home that she's lived in for 20 years outright, meaning she's paid off the mortgage. So taking out a loan against the property at a relatively low interest rate is an option. "This can be a reasonable approach, but it all depends on the interest rate on the home equity loan," says Mark Kantrowitz, the publisher of FinAid, a Web site that tracks the student loan industry.

Most home equity loans have fixed interest rates and 15-year terms. Borrowers can deduct the interest payment from their federal taxes if they itemize their deductions.

The downsides? Getting such a loan, for one, is tough unless you have considerable equity in your home. Second, you're putting up your house as collateral--meaning if you fail to make the payments you can lose your home entirely.

"Getting a home equity loan is good in theory," says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, a nonprofit group that helps consumers deal with debt, "but I'd eliminate a lot of other options before I considered this." Adds Kantrowitz: "If you default on a private loan, the worst thing they can do is garnish your wages. If you default on a home equity loan, the worst they can do is take your home."

Take out a home equity line of credit. This option is similar to a home equity loan, but with one key difference: Interest on home equity lines of credit (Helocs) are variable. As many mortgage borrowers have discovered, it's easy to jump at a teaser rate whose payments are within your reach only to have them ratchet up after you're on the hook. And once again, since the home is used as collateral, a failure to make timely payments can put it at risk.

Nor are Helocs necessarily in plentiful supply these days, due to the declining value of homes, and homeowners equity in them. A few years ago, Martin's home was valued at $450,000. Now, she would consider herself lucky if it were appraised at $170,000. A nearby home, which is owned by a bank, is on the market for $70,000.

Tap retirement savings as a last resort. If all else fails, it is possible for a parent to take out a loan from his or her tax-deferred 401(k). These loans are often available with minimum fees. The downside is that they have to be paid back within five years, and you're essentially required to repay your own account, plus interest that's typically a few points above the prime bank lending rate (currently 3.25%).

Restrictions abound. First off, most company plans allow participants to borrow no more than 50% of their vested 401(k) balance, or $50,000, whichever is lower. If you move to a new company, but keep your 401(k) savings in your old employer's plan, it's unlikely they'll permit you to borrow anything at all against it. IRAs, meanwhile, won't offer any help. The IRS forbids loans from most IRAs, and will only allow early withdrawals for medical or educational expenses.

"I'd never recommend using the money in a 401(k) for anything except retirement," says the National Foundation for Credit Counseling's Cunningham.


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