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The Worst Money Mistake Parents Make

Posted: 07/26/2012 9:38 am

As we all know, the cost of parenting can last long after the kids are grown and out of the house.

Let's follow the typical trail of cash flow as a child grows. Money spent on diapers and formula morphs into summer camp fees (unless, of course, you determined that's not the best use of your money) and back-to-school gear. Then, before you know it, you're paying for your kid's college loans well into your 40s and 50s.
Parents at Graduation
Okay, so that's probably not the way most parents envision spending their money as they near retirement, but unfortunately, according to recent data, quite a few are already feeling that sting. And it makes sense: The average cost of four-year universities rose by 15% between 2008 and 2010, and keeps on climbing higher.

Not every family is willing to tax themselves beyond their limits to meet those new sticker prices: Only 53% of parents said in a recent survey that they strongly agreed that they were willing to stretch financially to pay for college, down from 64% in the 2009-2010 academic year.

But if you're considering funding an increasingly expensive college education, there's a right way and a wrong way to go about it. Sending your kid to college? Good. Taking out loans in your name that you might not be able to pay back?

Well that's a financial road you don't want to go down ... and here's why.

The Truth in Numbers
Data released by the Federal Reserve Bank of New York last week shows that middle-aged Americans are actually the age group struggling the most with student loan payments. Not only has the number of middle-aged Americans in their 50s with student loans doubled since 2005, the delinquency rate (or the percentage of debt on which no payment has been made for 90 days) for borrowers ages 40 to 49 was 11.9%, compared to a delinquency rate of 8.7% for borrowers of all ages.

While it's definitely true that some of these over-40 debtors are still paying off their own loans from college, it appears that many are actually parents who have taken out student loans to help fund their children's education.

In fact, The Wall Street Journal reports that the federal PLUS program, a program allowing parents to take out loans for their kids to help pay education expenses not covered by other financial aid, is among the fastest-growing of the government's education loan programs.

Think Before You Borrow
Taking on loans to help a child through college is a noble goal ... it just might not always be the smartest financial move.

"Parents shouldn't sacrifice their own retirement to pay for their children to go to college," says LearnVest Financial Planner Sophia Bera, CFP®. After all, younger generations have more time and opportunity to pay off debt. Remember, your kids can take out loans for school, but you can't take out loans to pay for retirement."

Something else to consider--the current interest rate on PLUS loans is 7.9%. Bera offered up this example:

If parents were to take out a PLUS loan for $25,000, and repay it over the course of 10 years, they'd end up paying $300 a month because of interest, which makes the original $25,000 loan cost over $36,000 when all is said and done.

If, however, they instead put that $300 a month into a Roth IRA for 10 years at 7% interest, they would have over $52,000 saved for retirement. "That's the value of compound interest: It can work for you or against you," says Bera. "And think of this--even if your child doesn't graduate, you still have to pay back their loans."

How to Plan Appropriately
According to Bera, one of the best things you can do when considering how much you or your child can afford to put toward college is to sit down together and develop guidelines.

Coming up with a budget doesn't have to seem restricting--if you think your kid can get into an Ivy League school, encourage him to apply. Most Ivy League schools operate on a "need blind" admissions policy, meaning they consider students regardless of financial need. Admitted students are then given a tuition policy based on the student's family income. (The large endowments of such schools allow for generous financial aid packages.)

To figure out how much either you or your child can afford to put toward college loans, set up a budget that answers two questions:


  1. How much time do you have?, and

  2. How much can you afford to put away each month to reach that goal?

Start by comparing information about state schools where your child qualifies for in-state tuition and private universities. Once you have a good idea of the varying costs of tuitions, calculate how much you should save each month using our What to Sock Away for College calculator. If you're working with a limited timeframe (generally five years or less), you might need to figure out where you can cut back in your family budget to put aside extra money each month for college. (We talked more about the additional ways you can come up with money for college in a short period of time here.)

Although colleges have slashed the number of grants and scholarships they offer by 15% in the past year, don't forget the scholarship options available from private donors and funds. Click here to find out more about what scholarships are available for your child based on her unique background, interests, abilities and financial situation.

Something else to keep in mind--The White House, Department of Education and the Consumer Financial Protection Bureau unveiled the final version of their  "financial aid shopping sheet" on Tuesday, which is meant to replace the current (notoriously confusing) financial aid award letters that colleges typically send to students.

Colleges can voluntarily adopt the form, which includes, in one simple page, personalized information about how much one year of school will cost, the loan options available to the applicant, the differences between grants and scholarships and the net cost of college when grants and scholarships are taken into consideration.

While taking out federal loans is sometimes a necessity to fund college, it's important to minimize how much you borrow, and to go into it with a specific plan on how long it will take you to pay it back. For everything you need to know about student loans, check out our Student Loan Checklist in the Knowledge Center.

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LearnVest is the leading personal finance site for women. Need help managing your money? Our free Money Center will help you create a budget. Our free bootcamps will help you take control of your money, cut your costs or get out of debt. And our premium financial plans--managed by LearnVest Certified Financial Planners--can help you chart a course for the future you want.

 

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