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Changes to the 2022–23 FAFSA and CSS ProfileSuzanne Shaffer
Borrowing money to get what you want or need can make sense. However, too often it doesn’t, and the resulting debt is downright dangerous. For this reason, it’s essential to teach your high school or college student how and when to borrow the right way.
It starts with identifying the difference between good and bad financial obligations.
Before taking out a loan or charging with a credit card, your student should ask and answer the following questions:
Borrowing money to obtain a college degree or to run a profitable business is an investment, and usually a smart idea. With the high cost of housing, a mortgage is typically the only route to homeownership. Monthly payments build equity, and if all goes according to plan, the property will increase in value. While vehicle financing can be positive, most new cars and trucks lose at least 10 percent of their value the moment they leave the lot. Still, a vehicle is an asset — and for some of us, a daily transportation necessity.
Revolving debts, such as those incurred with a credit card, should be deleted (paid in full) each month. Loan payments are fixed, and as long as your student can meet them each month without sacrificing in other essential areas, all is well. It’s crucial to take the long view on student loans. Payments will start soon after graduation. The current average student loan debt for an undergraduate degree is around $30,000 with a monthly payment of $350. Your student needs to project deep into the future to determine if those payments will be manageable.
Your student must be comfortable with the length of time the debt will stick around. The standard student loan time frame is ten years, but can be accelerated or lengthened. A car loan lasting five years or more might be a daunting prospect. Your student should think hard about how long they really want to make those payments.
Unless your student is borrowing from a generous benefactor who won’t charge interest, they will actually repay quite a bit more than the amount they borrow. The total fees for a $30,000 student loan with a 6.8 percent interest rate on the standard payment plan are roughly $11,400. If the rate is 4 percent, the fees drop to about $6,400. As for credit card debt, a $5,000 balance on a card with a 21 percent rate will take 16 years and cost over $6,200 in interest alone if only minimum payments are made.
If your student answers “yes” to all the above questions, the debt is probably in the safe zone. If not, it should be avoided.
Many factors make up a “bad” debt, the first of which is emotional. A huge obligation that’s collecting fees and will exist for years is depressing. It’s even worse if your student has little or nothing to show for it.
The debt really becomes dangerous when your student misses due dates. Skipped loan and credit card payments are recorded on a credit report. Payment history is the weightiest credit scoring factor, so they will ding your student’s credit rating hard for years. Since lenders, landlords, insurance companies and many employers check credit reports and scores, a poor payment pattern can hurt your student’s lifestyle and opportunities.
Severe damage happens after many missed payments. The debt could go to collections, which will further hurt a credit rating. Your student can also be sued for a liability, causing a judgment to be placed. The debt will be higher as court costs and other fees are added. If the loan is secured, as with a car, the property will likely be repossessed. Then, not only will your student be without transportation, but a substantial unsecured debt will remain.
Finally, if a friend or relative was the lender, an unsatisfied debt can hurt a relationship. It’s possible to repair credit damage with an anonymous creditor; re-establishing trust with a loved one isn’t guaranteed.
Clearly your student wants to avoid these scenarios, which is why the above questionnaire is so important. It will help them make the best financial decision possible.
So your student needs to keep a watchful eye on account activity.
The best way to do this is to monitor statements on the lender’s website. For credit cards, all transactions will be listed in nearly real time. By checking on a weekly (or even daily) basis, your student can suspend charging before the balance gets too high for comfort. Additionally, this constant check-in enables them to spot errors and rectify them quickly.
Encourage your student to add highly-rated personal finance apps, such as Mint and YNAB (You Need a Budget) to their phone. The apps provide a detailed picture of a user’s cash flow and borrowing activity.
Even if your student prepares for a positive borrowing experience, troubles can arise. Sudden unemployment, an unavoidable expense or an illness all can impact their ability to meet payments.
Mistakes are also normal, and if your student has charged too much, a big balance can knock a budget off its axis. Whatever the reason, I recommend these steps:
Big choices — and big changes — are on the horizon for your senior and your entire family.