Take stock of existing student debt, but don’t delay starting to save for the next generation.
Lucy Knutson says she was fortunate because her parents helped pay for her undergraduate education. But when she decided to go to law school, she had to foot the bill, and she graduated with more than $100,000 in loans.Now that she’s a mom of two, she and her husband automatically put money from their paychecks toward college savings accounts for their almost 4-year-old daughter and 4-month-old son.
“If they want to go to college, I don’t want them to have to worry about the financial implications,” says the 33-year-old, who lives in the San Diego area.
Still, reducing her student loan debt is a high priority for the Knutsons, and they recently took out a loan against their 401(k) retirement plan to pay off the student debt faster and at a lower interest rate.
More and more parents are being pulled by a financial tug-of-war: They want to start college savings for their children but are still burdened with lingering student debt of their own. About 40 million Americans have at least one student loan to repay, according to an analysis from credit bureau Experian.
“It can be tricky for parents to find the right balance of priorities,” says Heather Jarvis, an attorney and student loan expert who trains and educates advisers on the topic. “We have our own student loans, and we also want to save for our children’s college education so our children don’t have to have as many loans as we do.”
There are some strategies that allow savers to do both.
1. Take stock of your debt: Parents need to understand what types of student loans they have: private or federal. The cost and repayment options can be quite different, Jarvis says.Federal student loans tend to be more flexible and have unique consumer protections, such as disability and death discharge provisions, opportunities to postpone or reduce payments, and repayment options that are tied to income.
“Private student loans are generally more risky and expensive,” she says. “There are many people who should focus on repaying private student loans before beginning aggressive savings for their children’s college education.”
Jarvis suggests making a full list of your loans – both private and federal – and their interest rates. To look up federal financial loans, go to the National Student Loan Data System for Students website or Studentloans.gov.
To get a list of all your student loans, including private ones, get a free copy of your credit report from annualcreditreport.com.
2. Consider debt interest rates: If you have student debt at a high interest rate, focus on paying off debt more aggressively, Jarvis says. Some people are paying interest as high as 8.5 percent for federal loans, while private loans can be between 15 and 18 percent, Jarvis says.
“You should really evaluate and critically assess the cost of your debt, and try to compare that to projected returns on savings and investments,” Jarvis says. “What you’ll find is that when debt is at a high, robust interest rate, it’s tricky to find investments that have those kinds of returns.”
However, borrowers with student loans at lower interest rates could take a slow and steady approach to paying off loans while also focusing on savings.
“If you’ve got loans at 3.5 percent, that’s a good interest rate,” Jarvis says. “That’s not costing you a lot of money. If that’s the case, I think your savings goals can take priority, as long as you know that you’re planning to save for a long enough time that you think you’re going to be able to recoup that difference.”
3. Don’t wait for the perfect time to start saving: “There’s really no good time to get started,” says Felicia Gopaul, a California-based certified financial planner and founder of College Funding Resource. “So the most important thing is that they get started.”
Gopaul says she sees her clients get caught up in other priorities and never start saving for college. And while having an emergency fund is most important, it’s also relatively easy to open a college savings account with a low minimum.
“Getting started with their college savings often gets put on the back burner because they think they’ve got lots of time, but time kind of marches on whether they save or not,” she says. “My suggestion is always to get started and start saving now.”
4. Make college savings automatic and funnel surpluses there: Gopaul says she’s a big fan of 529 plans, which are tax-advantaged college savings accounts, because parents can set them up so that money is automatically deducted from a paycheck or checking account.
She also likes the fact that parents “can’t touch” money in those accounts because there’s a penalty if you don’t use it for education.
If borrowers get a tax refund or a raise, she suggests using a portion of the money for college savings and putting some of the money toward paying down debt.