By : Reyna Gobel
Whether you’re deciding to help your student buy a new car, finance their education, or boost their credit by adding them as an authorized user to your credit card, you need to be aware of the financial consequences to your life and theirs.
We talked to Rod Griffin, Experian Consumer Education and Advocacy Senior Director, for his best tips for securing your family’s financial future.
Calculate the loan amount you could afford if your student can’t pay student loans back.
Often parents think of their student’s needs above their own. But over borrowing student loans hurts both parents and adult offspring. After all, who wants to fight about money post-graduation?
Thus, make sure before you consider co-signing anything, you could afford the loan if they can’t. This rule goes double when taking money out of your own pocket for tuition, a car, or any other items your student needs. Talk to your financial advisor to go over everyday spending, savings, and retirement numbers in detail.
Think about short-time goals like vacations, too. Calculating the amount you can afford to repay doesn’t mean you won’t co-sign a loan for your student. It’s choosing an amount that’s reasonable for your situation.
Consider your future borrowing needs.
Co-signing any loan for your student can stop you from getting approved for your next auto or home loan. The reason is these types of lenders consider your debt-to-income ratio, your debt payments as a percentage of your income, when deciding both your interest rate and whether to approve you for your loan at all.
For instance, let’s say your monthly income is $6,000. The mortgage lender you chose won’t approve anyone with a debt-to-income ratio of 43 percent. Thus, you aren’t allowed more than $2,580 in total payments. If your car loan payment is $400 and your student’s car or student loan would be $350, you’d have $2,150 max left for a mortgage.
Credit card approval is simpler. Generally, your fine as long as co-signed loan payments are on-time. Co-signed loan’s payment history counts on your credit report and to lenders the same way a loan does that is just under your name.
Act like a bank when co-signing loans.
Often, you’re co-signing a student or auto loan because your student can’t get approved on their own yet. While you don’t need to act as a bank when it comes to evaluating your credit score and history, you should act like a bank in terms of reviewing their ability to pay it back.
My son and my daughter both asked me to co-sign a car loan for them, says Griffin. My son asked me to co-sign a car loan on a Cadillac because the bank wouldn’t approve him for the amount of the loan. My daughter asked me to co-sign a loan for a used Kia that she had enough income to afford. She wanted me to co-sign because my credit score would drop her interest rate from 8 percent to 5 percent. I co-signed my daughter’s loan but not my son’s. His loan wouldn’t have good for either of our finances.
If you’re co-signing a private student loan, consider future income potential under their major and what a budget could look like. Career offices on campus have information on prospective salary information, and student life and money management offices can help create post graduation budgets.
If the loan payment would be too high in relation to a student’s potential salary, they may need to consider transferring schools or applying for more financial aid. An easy way to cut costs and semesters of loan borrowing is to take some basic courses at a community college. I personally know someone who completed her first two years at community college and finished at NYU. Community colleges across the country have transfer agreements with 4-year schools.
When I got my MBA, I took a semester worth of community college courses to make up for business courses I didn’t previously take as an undergrad. I saved thousands.
Add your student as an authorized user without giving them a copy of the credit card.
It is an age-old trick for creating a solid credit history to gift your credit to your student by adding their name as an authorized user on your card. Your student could be 18 years old and have a 25-year credit history because of your credit card’s open date.
Since you are gifting your credit, don’t make it a gag gift. Choose the card with the lowest utilization rate you have. The utilization rate is the percent of the total available balances you’re using. For instance, if your card has a limit of $5,000 and your balance is $500, your utilization rate is 10 percent. A very advantageous rate for your student to show up on their credit report. An on-time payment history also adds to the gift. It’s the bow.
Finally, make the gift conditional. If you know your student isn’t ready for the responsibility of giving them their own credit card to access your account, don’t. They still get your credit card’s payment history, etc. reported to the credit bureaus as an authorized user without the card.
Have financial check-ins before borrowing more money.
If you’re taking out loans in your name or co-signing loans for your student’s education, you didn’t enter a forever contract with them to continue to borrow for their education every semester. Talk to them about grade, financial, and career exploration responsibilities for you to keep funding their education.
Ask to see budgets or at least discuss them. If it’s your investment, you want to make sure they are proceeding in a way where either they’ll repay the loan or they have a good chance of getting a job and not moving home after graduation. Career exploration ranges from shadow days to internships and part-time jobs. Your student should meet with career services every semester to develop and adjust their career exploration game plan. However, it’s always best not to make one of the conditions choosing a high-paying major for them.
Choose carefully who borrows student loans.
One of the biggest mistakes parent make is to borrow money under their own name before students borrow federal student loans. Federal loans to undergraduate students have options for keeping payments manageable such as income-based repayment.
If you do decide to borrow to help your student out after calculating what you can afford, review all your options. Sometimes you’ll get a lower rate as the parent borrowing than the student. And then there’s no debate in who’s responsible for the loan later.
Watch your overall credit habits if borrowing or co-signing student loans.
More debt (student loans) means more responsibility within your credit score, says Griffin. Thus, if you miss a payment on a credit card, it may cause a bigger drop in your credit score because you have more debt. There’s no exact number for how many points having student loan debt can affect you.
However, it does affect people with not-so-great credit more. For instance, a student loan listed on a credit report of someone using less than 10 percent of available credit card balances and pays all their bills on-time causes minimal impact. Someone who’s credit score is 600 or below may have a much higher impact.
Congratulations on raising a future college graduate. Just don’t let the cost of college or the car they want hurt your financial future. Make financing decisions based on the impact on your financial life, too.
Your student will still live a great life with some education debt, and an even better one when you’re a role model for good financial decisions.