What you don’t know can hurt you. American borrowers owe a record $1.2 trillion in student loan debt, a number that has tripled in the last ten years, according to Sallie Mae. Within those numbers, nearly one million retirees are saddled with $18 billion in outstanding student loans, a dollar amount that has risen 600 percent in the last decade.
Average student loan debt grows every year. Graduates today walk away from school owing about $35,000. At least 23 percent of American adults have some education debt, including debt for their spouse or partner, or a child or grandchild. The numbers are higher for households headed by young adults – more than 40 percent carry student loan debt.
Millions of people owe but did not complete a degree program. People who take on student loans but do not complete their degree are more likely to fall behind on payments, according to a survey by the Federal Reserve.
1. You Can’t Bankrupt Student Loans
While it’s possible to have a student loan discharged in bankruptcy, it’s extremely difficult and rarely happens. In general, student loans must be repaid even if the borrower does not complete the program, cannot find a job or is in some way dissatisfied with the education purchased with the funds. Exceptions are made for borrowers who become totally and permanently disabled or who die.
To bankrupt a student loan, the borrower must prove to the court that the loans cause undue hardship. This is quite difficult. Repayment must prevent the borrower from maintaining a “minimal” standard of living; there must be evidence that the hardship will continue for “a significant portion” of the repayment period; the borrower must have made good faith efforts to repay the loan, for a minimum of five years. If any one of those conditions cannot be met, the loan must be repaid.
Far more likely is an offer for deferment or forbearance. Payments are suspended, but will eventually resume. On some types of loans, the government will pay the interest charges during a deferment. During forbearance, the interest continues to accrue.
Additionally, per the Fair Credit Reporting Act (FCRA), most derogatory information remains on your credit reports for between seven and 10 years, depending on the item. But the one item that is not addressed in the FCRA is the student loan. The amount of time a defaulted student loan can remain on a credit report is instead found in the Higher Education Act, which says that student loans can remain on your credit reports until they’ve been paid.
2. Student Loans Can Prevent You From Buying a Home
Getting a mortgage depends on many factors. If you’re planning on buying a home and have outstanding student loans, there are two ways student loans come into play when you’re applying for a mortgage.
First, payment history. The mortgage lender is not likely to approve an application from a borrower whose credit report shows late payments. Some lenders will not allow more than one 30-day late payment during the past year. Few, if any, lenders will approve an application from someone who has paid a bill 60, 90 or more days late. So if the borrower has struggled at all with payments on the student loan, mortgage lenders might turn away.
Second, debt ratio. To qualify for a mortgage, your new mortgage payment cannot exceed a certain percentage of your income (usually around 28 percent). Furthermore, the total of all of your debt payments, including the new loan, cannot exceed a certain percentage (usually 36 to 40 percent). So a borrower who earns $40,000 per year might be approved for a mortgage if the payment, including taxes and homeowners insurance, does not exceed about $933 AND if the borrower’s total debt payments, including the mortgage and any credit cards, student loans, auto loan and other monthly obligations do not exceed $1,333. That’s not much wiggle room. Since the average student loan payment is over $600 per month, many borrowers will be excluded from even a modest mortgage if it hinges on his or her debt ratio.
3. Co-Signers Suffer Just as Much or More Than Primary Borrowers
Co-signing means taking full financial responsibility for a loan in the event the primary borrower defaults. At the time the loan is needed, the co-signer wants to help. The harsh reality is that if the borrower can’t qualify for a loan, it’s much smarter to help him improve his own credit standing than to co-sign for the loan. None of us wants to be saddled with the financial obligations of someone we tried to help with education financing. But that is the door we open when we co-sign.
Think the student loan will fade into memory when you’re old enough? Think again. Many well-meaning parents and grandparents discover that unmanageable student loan debt follows them into retirement, offering no reprieve to older Americans who have stopped working and begun to live on a limited fixed retirement income. Hundreds of thousands of retirees have their social security checks garnished to repay student loans in default.
Even with the best intentions, co-signing is a bad idea. If the borrower defaults, both signers’ credit suffers equally. Since the repayment period on student loans usually ranges from ten to twenty years or even longer, the risk remains for a very long time.
Avoiding Student Loans
Today’s students are tasked with the steep challenge of getting an education without an unmanageable price tag. Parents today can set up pre-tax accounts for children’s education. Students must apply maximum effort to finding grants, scholarships and other school funding. The trick is to avoid the student loan trap. Knowledge is the first step.
Here’s the issue. The CARD Act prevents someone under 21 from getting a credit card, but there is no law preventing an 18 year old from getting into student loan debt. If an 18 year old isn’t responsible enough to open a credit card, how are they responsible enough to decide that $20,000 per year for the next four years is a smart financial decision?
The challenge is, having a fully successful credit talk with college-bound high school kids is like trying to explain to a non-parent how it is to have an infant… it’s next to impossible. That certainly doesn’t mean you throw up your arms and leave your 18-year-old to learn about credit through trial and error.
There are some angles for getting your message across, successfully. Here are my suggestions.
Show, Don’t Just Tell
I think trying to tell young kids that they should avoid credit cards is about as effective as telling them not to drink. In fact, I would suggest giving your kids a credit card a year or two before they’re packing for college. It would certainly grab their attention and it gives you a controlled environment in which to teach them the right and wrong way to manage the card. It’s not unlike a learner’s permit for a credit card.
Share Your Mistakes
I’m not so far removed from that group that I don’t remember how I was. I didn’t want to listen to anyone, especially people coming to talk about a boring topic like credit reports and credit scores. I certainly didn’t care about my credit when I got to college, which is probably why I cheerfully filled out and returned that student credit card application waiting for me in my student mailbox.
I know a $300 credit limit isn’t much but I sure did some damage! Thankfully, I was responsible enough to make the minimum payments. By the time I graduated, I had about $1,700 in credit card debt, which in the grand scheme of things isn’t a lot unless you’re unemployed and living at home with your parents. Brutal!
Bring Out the Job Card
I’ve been taking the “some employers look at credit reports” angle lately. It’s 100% true and it’s heavy artillery. Nothing shuts up a room full of high school kids faster than telling them that their impressive (and expensive) college degrees can be somewhat negated by a poor credit report caused by not paying their utility bills at the frat house.
Take It Seriously
I know what some of you are thinking: Are you serious? Not only am I very serious, I believe parents who pretend that their kids aren’t going to try new things in college have their heads in the sand, which is dangerous. Avoiding the credit card talk is no different than avoiding other critical topics like unprotected sex, “no means no”, drugs, tattoos, and drinking and driving.
Don’t get me wrong: you don’t have to be Cliff Huxtable to have this discussion. And you certainly don’t have to convey your thoughts in a way that would win you an Emmy award. There is no script. There are no “best practices.” Nobody knows the best way to convince your kids that using credit while away at college is perfectly fine — if you use it responsibly.
Just don’t let them walk out that door without making an effort.
