With the financial crisis of 2008 and the poor economy that followed, many parents found themselves unable to assist with college tuition costs. At the same time, cuts in state funding meant fewer grants and scholarships were available, turning students to government-backed student loans to finance their tuition.
New graduates are now discovering that jobs are scarce. As a result, student loan default is at a historic high. The average college student who graduated in 2011 had $26,600 in student loans, according to the Institute for College Access and Success.
Many factors have caused this high student loan debt and default scenario, but students and their parents need to understand the ramifications of defaulting on a student loan. In addition, parents need to think carefully about co-signing for a student loan and what that could mean to their own financial future.
Should you co-sign?
To attend a four-year college, your child may want you to co-sign for a student loan. Before you say yes or no, you need to educate yourself. If your son or daughter ultimately can't keep up with the loan payments, that loan becomes your loan. If you can't afford to make the payments, your credit report is going to take the hit.
Only private student loans, such as those through a financial institution, require co-signers. Federal student loans — 93 percent of student loans are now issued by the government — do not require co-signers. Government-backed student loans typically offer lower interest rates and more flexible repayment plans. Investigate all options before co-signing anything.
Defaulting on a student loan
If you or your child does default on a student loan, the government isn't going to let either of you walk away. The government has many options available to recoup its losses:
Tax refund offsets — The IRS can hold onto any income tax refund you may be entitled to until your student loans are paid in full.
Garnishment of wages — The government can garnish (take) a limited portion of the wages of a student loan debtor who is in default. It can take up to 15 percent of your disposable income. However, it cannot take more than the equivalent of 30 times the current federal minimum wage.
Federal benefits — The government can take some federal benefit payments (including Social Security retirement benefits and Social Security disability benefits, but not Supplemental Security Income) as reimbursement for student loans. The government cannot take any amount that would leave you with benefits of less than $9,000 per year, or $750 per month. And, it cannot take more than 15 percent of your total benefit.
Legal action — The government and private lenders can sue you to collect defaulted student loans. Unlike other debts, there is no time limit on suing to collect student loans.
In the event of bankruptcy
If you're having trouble repaying your loan, the first thing you should do is contact your student-loan lenders to see if you can arrange an easier repayment plan.
If you're having serious trouble paying back your debt, bankruptcy isn't going to be an option. Unlike credit-card debt or automobile loans, student loans are virtually impossible to discharge in bankruptcy.
Unless you can show that your education loan payment is an "undue hardship" on you, your family and your dependents, your student loans are ineligible for cancellation (discharge) in bankruptcy. It is difficult to prove "undue hardship" unless you are physically unable to work and there is no chance of your making money. To discharge your student loans under this special case, you must file a separate motion with the bankruptcy court and present your situation before a judge.
If student loans are the largest part of your debt, you are better off not filing for bankruptcy, because courts are very reluctant to discharge student loans.
A CPA can help
Student loans play a vital role in financing higher education for many students. While loans may seem like free money when you're still in college, you should never borrow more than you need. Federal loans are easy to get, so make sure you can pay back whatever you borrow.
If you have questions about your student loans or other personal financial planning topics, contact your CPA. To find a CPA in Pennsylvania by location or area of expertise, visit www.Ineedacpa.org.
For more information about Pennsylvania Institute of Certified Public Accountants (PICPA), visit www.ineedacpa.org.