The Money Class

by Suze Orman

  If you investigate an age-based fund within a 529 and are comfortable with how it ratchets down your stock allocation as your child progresses through high school, then that is fine. But please make an informed choice. You can always build your own portfolio by choosing from among the other investment choices offered within the 529 plan.

  Here is my suggested allocation:

  Under age 14: 80–100% stock mutual funds

  Age 14: 75% stock funds

  Age 15: 50% stock funds

  Age 16: 25% stock funds

  Age 17: 0% stock funds

  TIP: One absurd restriction imposed on 529 investors is that you are only allowed to change your asset allocation once a year. Please be aware of this rule and make sure you complete all your rebalancing at one time.

  If you do not choose the age-based all-in-one fund offered within the 529 (on this page I explain why I do not like these all-in-one funds), then the advice on investing your 529 echoes the advice in the retirement chapters: The bulk of your stock allocation—I recommend 85%—belongs in large U.S. blue-chip firms. If you see a fund with the words “S&P 500 index,” that is a good choice. Or any fund that is described as investing mostly in “large cap” stocks. The remainder of your stock allocation can be invested in an international stock fund or ETFs. We live in a global economy; while your U.S. blue chips typically derive plenty of their business from foreign markets, it’s also smart to have a small portion of your stock portfolio directly invested in an international fund.

  For the portion of your portfolio not invested in stock funds, I recommend you stick with the cash or CD option within your 529. As I explain in the Retirement Classes, I have never liked bond funds. And with my expectation that in the coming years interest rates will rise from their current historic lows, bond funds will face especially rough headwinds.

  THE COLLEGE TALK EVERY PARENT MUST HAVE WITH A HIGH SCHOOL FRESHMAN

  As a family you need to start talking about college finances no later than freshman year in high school and begin to map out a strategy that will make college affordable.

  Explain what you expect to be able to contribute to annual costs. Your child deserves to understand exactly what, if anything, you will be able to contribute to his four years of college costs. Waiting until senior year to spring the news that you have little or nothing is unfair. By having the conversation earlier you give your child the opportunity to plan.

  Put a financial safety school on your list. Guidance counselors are quick to talk about applying to at least one school your child will easily be accepted into. I would take this strategy one step further and make sure you have a financial safety school: Plan on applying to a public in-state school that you know will be affordable. A public four-year school can cost one-half to one-third what it costs to attend a private four-year college. If your child qualifies for a generous financial aid package at a private school, that’s great. But the idea here is that in the event the aid package at an expensive school isn’t generous enough, you will have an affordable option to fall back on.

  Strive to make the most of high school. Once you explain your financial situation to a high school freshman or sophomore you give them even more incentive to do well in school. Every A they receive now can help them qualify for financial aid. Advanced Placement classes can also help all of you save on college costs: Many colleges will waive some basic required courses for students who score well on the AP test.

  TIP: Mark Kantrowitz, the wizard behind FinAid.org, also has the inside scoop on winning scholarships to offset tuition costs. If you have a child in high school, I would recommend you take a look at his new book, Secrets to Winning a Scholarship. The price is under $10 because Mark wants it to be available to everyone, including low-income families who could benefit the most. I approve!

  Start the loan conversation. In the next lesson I will explain the best ways to borrow for college. One of the hardest steps in this process is for you and your child to limit what you borrow for school. Just because someone will loan you $40,000 a year—and yes, you can borrow that much or more—does not mean you should. As a family you must stand in the truth that the goal is for your child to emerge from college without anyone in the family being saddled with so much debt that they will not be able to reach their other financial dreams.

  BORROWING RULES FOR COLLEGE LOANS

  As I stated at the beginning of this lesson, college is a smart investment. And I absolutely believe that college loans are “good debt.” But too much of a good thing can become a bad thing. You and your children need to borrow wisely. One of the problems with the college loan system is that there are not any checks and balances to prevent you from borrowing more than you can afford. That just makes it all the more important for your entire family to stand in the truth—together—and create a borrowing plan that will allow both student and parent to easily handle the eventual payback of the loans. You need to understand that college debt, whether it is taken out by the student or the parent, is currently not eligible to be discharged in the event you file for bankruptcy. It literally stays with you forever. See what I mean: You need to really be careful in how you borrow for school, and how much you borrow.

  Most families will qualify for some amount of need-based financial aid. You can get an estimate of what your family might qualify for here: http://bit.ly/a6VEJ. We all know that it is rare that your child will get a complete “free ride.” So your family will need to cover the portion of the bill that exceeds your aid. You can of course use your current income, as well as tapping any college savings funds, such as a 529. But it is also likely you will need to take out loans as well.

  This is how you are to approach the loan part of the college financing puzzle:

  Student borrows first using a federal Stafford loan.

  Parent considers borrowing using a federal PLUS loan.

  Neither student nor parent uses a private loan

  Please follow this strategy closely. Federal loans are the only loans you should ever take out. They charge reasonable fixed interest rates, and borrowers have a few different repayment plans to choose from, including plans that will allow you to defer, delay, or reduce your payments if you lose your job or experience financial hardship.

  The Risks of Private Loans for College

  Private loans offered through banks typically charge a variable interest rate. The starting rate is often higher than the fixed rate on federal loans. And listen to me here: General interest rates in the coming years are likely to move higher. When that happens, the interest rate charged on private student loans will also rise. That alone is enough reason to steer clear of private loans. But there’s another reason why I want you to stay away: If you fall into financial trouble once you are in repayment, private lenders have no obligation to help you out with a different payment schedule. What is most galling is that in the event a private loan borrower dies, the debt may still be owed. With federal loans, the debt is forgiven in the event the borrower dies or becomes permanently disabled.

  My opinion is that private student loans should never be used. Period. If that means your child needs to consider a less expensive school, then that is the truth your family needs to stand in, united as one.

  Alert: What to Do If You Already Have a Private Loan

  If you already have a private college loan or you have cosigned for someone who has taken one out, I insist that you take out a term life insurance policy that can cover 125% of the current loan amount. As I just mentioned, in the event someone with a private college loan dies, the loan may not die. It is up to the lender to decide if it will still demand repayment. By purchasing a term life insurance policy, your family—or your cosigners—could use the death benefit on the policy to repay the loan. This is an incredibly cheap way to protect your loved ones. The term policy should be for a minimum of 10 years after the student is scheduled to graduate. Given that many borrowers need even longer to repay their college loans, I would recommend you consider a
15-year or 20-year policy. I also recommend that the amount of your policy be 25% or more than what you currently expect the loan’s expected total cost to be. Why? In order to provide some insulation from rising interest rates—remember the private loan is a variable rate—and the fees that the banking industry is expert at finding reasons to charge you. So for example, let’s say you have private loans that you expect will end up costing you $50,000 to repay. I would consider a 20-year level term life insurance policy with a death benefit of $62,000 or so. For a 20-year-old male in good health that policy might cost $10 to $12 a month. That’s it. Less than $150 a year to protect your loved ones from having to finish paying off your private student loan. And purchasing term life insurance is really simple. You can learn more at the websites of term insurance specialists SelectQuote.com and AccuQuote.com.

  HOW TO BORROW FOR SCHOOL

  When your child applies to college you should complete the Free Application for Federal Student Aid (FAFSA) form. Schools require the FAFSA form to determine your family’s eligibility for financial aid. It is unlikely that grants and scholarschips will cover all your costs. If you can’t make up the difference out of your current income or savings, your next move will be to take out loans. Families that meet a low-income test may be able to borrow up to $5,500 a year at a fixed interest rate of 5% through a federal Perkins loan; every school administers Perkins.

  Student Borrows First: Stafford Loans

  Your child is to borrow for school before you take out a loan. The federal Stafford loan program is hands down the best college financing deal out there that is available to everyone, regardless of need.

  There are in fact two types of Stafford loans: subsidized and unsubsidized.

  A subsidized Stafford loan is based on financial need. For the school year that ends in July 2011 the fixed interest rate on a subsidized Stafford is 4.5%. For the 2011–2012 school year the fixed interest rate will be 3.4%. The interest rate for loans taken out in the 2012–2013 school year will be at a fixed interest rate of 6.8% and under current law will remain at that level in subsequent years. The government pays the interest on subsidized Stafford loans while the student is in school and during a six-month grace period after the student graduates (or leaves school). Once the student begins repayment he or she is responsible for the interest payments.

  An unsubsidized Stafford loan is available to all students regardless of financial need. The fixed interest rate is 6.8%, and the student is responsible for paying the interest while in school, or the interest can be added to the loan balance. My recommendation is to try to pay that interest while you are in school; a part-time job or maybe some help from mom, dad, or grandparents will help keep the loan balance lower so when repayment begins within six months of leaving school you will have a smaller balance to pay off. At www.direct.ed.gov/student.html you can find more information about Stafford loans, including calculators to help you estimate what your payments may be based on a few different plan options.

  STAFFORD LOAN LIMITS

  For the 2011–2012 year the student can borrow the following amounts based on their year of school:

  MAXIMUM STAFFORD LOAN LIMIT

  Freshman $5,500 (no more than $3,500 may be subsidized)

  Sophomore $6,500 (no more than $4,500 may be subsidized)

  Junior $7,500 (no more than $5,500 may be subsidized)

  Senior $7,500 (no more than $5,500 may be subsidized)

  I am fine with every student borrowing these maximum amounts. Graduating with a total of $27,000 in debt is not an amount that will bury you. A good rule of thumb is to keep your borrowing below what you expect your annual starting salary may be at your first job. Assuming the student has picked a field that pays a starting salary of $30,000 or more, paying back the Staffords is realistic.

  Go to The Classroom at www.suzeorman.com:

  Find guidance on my website about what factors to consider when determining how much young adults can honestly afford to borrow for college.

  Parents Borrow Next: PLUS Loans

  If the financial aid package and Stafford loans are not enough to cover the cost of school, your family’s next step is to consider the federal loan program for parents of college students: the PLUS program.

  I think the federal PLUS loan program is terrific. It charges a reasonable fixed interest rate of 7.9%. There is also a 4% fee on the initial amount of the loan. Like Staffords, the PLUS program offers a few different repayment schedules based on your financial needs. Most important, if the parent dies or is permanently disabled, the loan is forgiven.

  That said, not every parent should take out PLUS loans to help pay for college. In my opinion, you should meet the following standards:

  You pay off your credit card each month, in full.

  You have an eight-month emergency fund.

  You are on track with your retirement savings.

  Please stand in the truth here: If you have not taken care of those financial priorities you are not in a position to borrow for a child’s college costs. Your financial security is not yet firmly in place. Borrowing more at this juncture would just put you further away from reaching those more pressing financial goals.

  Qualifying Rules for PLUS Loans

  Your FICO credit score is not a factor in qualifying for a PLUS loan. Your credit report will, however, be checked to confirm that you are current on all your payments—meaning no payments are ninety days past due—and that you have not declared bankruptcy or gone through a foreclosure in the past five years. (Short sales, however, are okay—you can still get a PLUS.)

  If you are not eligible for a PLUS loan, you will want to notify the financial aid office at your child’s college; your child may be eligible for more aid from the school and could qualify to borrow more from the Stafford program. When parents are ineligible for a PLUS, the unsubsidized Stafford loan limit rises to $6,000 a year for freshmen and sophomores and $7,000 a year for juniors and seniors. At FinAid.org, which is run by college financing expert Mark Kantrowitz, you can learn more about all federal loans.

  How Much to Borrow in PLUS Loans

  One of the flaws of the PLUS program is that it does not set any borrowing limits based on your income. The basic rule is that you can borrow up to the total cost of attending school, minus any aid your child receives. But please, parents, do not tell yourself that you can afford any amount.

  My recommendation is to use the calculator at the College Board website (www.collegeboard.com) to get an estimate of what your payments would be. You are to borrow only an amount that you are confident you can repay out of your monthly cash flow and within 10 years of your child leaving school.

  For parents who may have used a PLUS loan in the past, I want to point out that an important change was instituted in 2008. Instead of being required to start your repayment of the PLUS loan within six months of receiving the loan, you can now defer your payments until your child leaves school. This can make it easier to pay some costs while your child is in school, and then handle the repayment after school. It also means that your child will be out of school and may be able to chip in some money to help get your PLUS loan paid off sooner rather than later.

  HOW TO CHOOSE THE RIGHT SCHOOL

  Okay, let’s pull this all together. When your child is accepted to colleges, you will be given your aid package and what your family’s contribution is expected to be. I am not exaggerating here: This could be the biggest stand-in-the-truth moment for all of you. I need you to understand what I mean by “the right school.” The right school is the best school that is also affordable. That means you and your child can swing the tuition from a combination of current income, 529 savings, Staffords, and borrowing a reasonable amount in a PLUS.

  If you find yourself contemplating borrowing more from a PLUS, or you or your child is considering a private student loan, please stop yourself right there. Take a deep breath and stand in the truth. You are about to make a financially dishonest choice that could undermin
e your family’s long-term financial stability. Remember, cost matters. The annual cost for a four-year state school for an in-state resident was about $15,000 in 2010. For an out-of-state student attending a public school the average cost was $26,000. At a private four-year school the average cost was more than $35,000. If the more expensive schools do not offer you enough financial aid, the honest move is to consider the school that will not hijack your ability to realize all of your family’s financial dreams, not just paying for college.

  And if the cost of an in-state school is still too high, you and your child should consider having him start at a community college. Your child could live at home—a big cost savings—and then after the first year or two, he can look into transferring to the in-state school.

  LESSON 4. HOW TO HELP ADULT CHILDREN FACING FINANCIAL CHALLENGES

  The empty nest isn’t what it used to be. Life postcrisis shows that more college graduates are moving back home with Mom and Dad, sometimes out of necessity if they have yet to find a job, but also because they know that the house they grew up in is going to be a lot nicer than what they could afford on their own. And having to move back with your parents doesn’t carry the same stigma as it did years ago. A survey by Monster.com reported that 52% of 2010 college graduates who have a job had nonetheless moved back in with a parent or guardian. At the same time, many adult children who have been independent for years are now facing financial challenges—a layoff, a too expensive mortgage—that have them turning to their parents (and grandparents) for help.