Is Student Debt Still Good Debt?

Financial Wellness By Noah - April 7, 2021

If you have a rising college student in the house, this spring is an exciting time for your family. Many colleges are sending out information about financial aid and awards, so it’s time to make final decisions about where students will spend their college years—and how families will pay for it.

At one point, common wisdom said that student debt was a form of “good debt” and an investment in your future. But some parents who are still paying off their own debt while considering their child’s college plan may disagree. Now is a great time to evaluate your options to balance a rewarding education with a strong financial foundation.

What Makes Student Debt “Good Debt”

Unlike forms of "bad debt" like auto loans and credit cards, common financial advice has often put student debt into the “good debt” category. Like the other major form of good debt, mortgages, student debt pays for something that doesn’t typically lose value over time. A homeowner may expect their home to appreciate in value, and a student expects their college degree to provide them with valuable knowledge and expanded professional opportunities.

Student loan debt can also have a positive impact on your credit score because your payment history appears on your credit report. By making payments on time, college graduates will build creditworthiness (payment history makes up about 35% of your credit score, so timely—or late—payments can have a big impact).

What Makes Student Debt “Bad Debt”

Even if you are borrowing money for a good reason, such as to finance higher education, debt is ultimately still a financial burden. Parents of incoming college students may know this well. Over 14 million student loan borrowers aged 35-49, and 6.2 million borrowers aged 50-61, carry an average balance of $42,000 for their own college education. Decades of paying off their own debt can leave parents understandably uneasy about encouraging their children to take out loans—or shouldering more debt themselves.

In many cases, student loan interest becomes a big part of the burden. Federal student loans often set lower interest rates for undergraduate, graduate, and professional students than for their parents. So, an undergrad student taking out a subsidized loan may have a 4.53% interest rate, but their parents may face 7-8.5% interest for some Direct or Federal PLUS loans. Private loans may carry even higher interest rates. (At the moment, coronavirus relief includes a moratorium on federal student loan interest, but as of now, it ends on September 30, 2021.)

Many student loans accrue interest from the moment they’re opened, meaning interest adds up during college years and periods of deferment. With subsidized loans, the U.S. government pays interest accrued during student years, 6 months after graduation, and in deferment periods. Unsubsidized and private student loans don’t carry this benefit. Accrued interest can end up being capitalized, or added to your principal balance, so new interest payments are based on the original loan amount plus the accrued interest. This can lead to interest accumulating much faster than borrowers expected, making it hard to get over the interest hump and make a meaningful dent in the principal balance.

Finally, student debt is notoriously difficult to discharge, even in bankruptcy. Some politicians, including President Joe Biden, have discussed student debt cancellation as a priority, but it’s unclear when any such measure may pass or how much student debt forgiveness will be available. Any future student loan forgiveness programs may also only apply to federal loans, leaving borrowers with private loan debt to deal with repayment on their own.

Should Your Child Go to College?

Rising college costs and the economic impact of the coronavirus pandemic have also prompted conversations about what to do after high school graduation. Many Millennials grew up in a culture which promised that a four-year degree was almost universally worth it for greater earning potential and job opportunities. Now, barely over half of high school students plan to attend a four-year school. Gen Z is increasingly interested in skills and career training, with 74% saying skills-based education such as trade school makes the most sense in today’s job world, and 61% saying the top place to learn is on the job.

Families that are still planning to send a student to college have an opportunity to build strong financial habits as well as planning higher education:

  • Talk to your child about their contribution to college expenses: A high school grad may be able to get a summer or part-time job to save for textbooks, or make a plan for work study or campus job options if those are available at the college.
  • Discuss how student loans work: Incoming college students may have little experience understanding interest, principal, and other ins and outs of loans. Make them part of adult conversations about which options are realistic and how loan payments work.
  • Choose what fits your finances: A “dream” school that offers insufficient financial aid may not be a realistic choice. Be open about which colleges are affordable. You might even discuss doing a year of community college and transferring gen ed credits to a four-year college later.

Can My Home Equity Lower Financial Aid Packages?

If you’re sending a child to college in the fall, you likely already filled out the free application for federal student aid (the FAFSA). You’ll need to fill out a new FAFSA for every school year, and in some cases, the CSS Profile as well. Many parents wonder which assets, including home equity, could cut into financial aid eligibility.

Most colleges use the FAFSA to decide a student’s financial need and aid package. If your financial aid is based on FAFSA, home equity in your primary residence won’t factor into the aid calculations (although if you have a vacation home or rental property, that equity does count as a reportable asset).

The CSS Profile on the other hand does count your home equity as an asset. Colleges and universities using the CSS Profile set their own guidelines for how to calculate the impact of home equity on financial aid. They may cap home equity at a certain multiple of parent income (e.g., if you bring in $90,000 and the cap is two times income, only up to $180,000 in home equity would count toward financial aid calculations). Some colleges and universities that use the CSS Profile, including Stanford and Harvard, exclude home equity from their financial aid calculations altogether. If a college does count home equity, they’ll likely assess it at around 5%, like most other parents' assets. In other words, for every $100,000 of equity you own in your home, expect the financial aid package to drop by around $5,000.

The best CSS Profile tips and tricks to optimize financial aid include:

  • Don’t overestimate your home’s value. Home value assessments can vary. You should of course be honest, but it might make sense to go with a conservative estimate.
  • Check how the schools you’re considering calculate home equity as an asset, and prioritize schools that count the lower amount or exclude home equity.
  • Get the CSS Profile in as early as you can to take advantage of first-come, first-serve financial aid allotments.

How to Use Home Equity While Financing College

One thing’s certain: You don’t want to put your home at risk to finance a child’s bachelor's degree. If you’re overextending your finances to figure out college payments, that’s a sign that you may have chosen the wrong college or the wrong timing. What is true, however, is that savvy use of home equity financing can be part of a larger financial strategy to transition to a new phase of family life.

Sending kids to college can be a step toward other major transitions. Parents may be interested in moving to a home that reflects post-childrearing couplehood or exploring a new career path.

Accessing home equity funding through a Home Value Investment can be another tool in your toolbelt to manage multiple financial priorities at once while keeping your DTI in check. Unlike taking out a HELOC for college tuition, you won’t have to deal with variable interest rates and a lender who might suspend your access to funds. Some beneficial ways to use home equity could include:

  • Paying off your own student loans in full before co-signing onto any loans for your child
  • Getting funds for home renovations that could boost your home value for a future sale
  • Paying down credit card or personal loan debt in one lump sum to reduce your monthly payments
  • Reviewing your personal finances with a qualified professional to assess whether a strategic reduction in home equity could optimize your financial aid package

Figuring out how to pay for college can feel like an education in and of itself! The difference between good debt and bad debt, and the responsibility involved in carrying debt of any kind, is an important lesson for students to learn before they even set foot on campus. Reviewing financial aid together and choosing a college wisely can be an important way for parents and students to recognize this significant step into new adulthood.