Paying off the Student Loans of Your Adult Children

student-loansA major financial consideration many parents face is the decision to help pay off the student loans amassed by their adult children.  When parents are financially secure and their children are not, it can be emotionally difficult to watch their kids struggle.  It gets more complicated when one or more children in a family earn college scholarships, use the GI Bill after a stint in the military, work part-time throughout college, or pursue degrees in lucrative professions, while other siblings goof off in high school resulting in no scholarships, travel and hang out with friends during the summers instead of working, or pursue careers that can’t service their student debt load after graduation.  

Everyone loves to brag about the son or daughter who is doing well financially, but a struggling adult child seems to shout from the mountaintops our own parenting deficiencies.

Successful children are a source of parental pride.  Everyone loves to brag about the son or daughter who is doing well financially, but a struggling adult child seems to shout from the mountaintops our own parenting deficiencies. In some cases we feel responsible for our children’s student loan debt because we encouraged them to go to expensive prestigious colleges rather than schools they could afford.  Parents who are proud their kids were accepted into expensive schools often don’t think about how the tuition will be paid, and they can unknowingly put tremendous pressure on their kids to take out massive student loans because the kids don’t want to disappoint mom and dad by dropping out to attend a more affordable school.

Regardless of the reasons why kids graduate buried under a mountain of student loans, we still love them, and we don’t like watching them struggle. We want them to own their own homes, take vacations, and provide nice things for our grandkids.  When they are financially strapped because of student loan obligations, it makes us feel sad.  Because every situation is different, there really isn’t a once size fits all solution; however, I will touch on some options I have seen practiced over the years.

Don’t help with the student loans at all

While this is usually the best financial option for the parents, it can also be the most emotionally challenging, particularly if the parents routinely bailed the kids out while they were still living at home, but now have decided to practice tough love. Real life is a cruel professor, but when parents require their children to be responsible for their own student loans, the kids eventually figure out how to manage.

An additional point to consider is paying off a child’s student loans offers no assurance the kids will enjoy good financial outcomes in the future. If mom and dad pay off the student loans but the kids haven’t learned sound money management, it is possible they will merely use the opportunity to go into debt some other way.

Loan children the money to pay off their student loans

With student loan interest rates in some cases twice those of home mortgages, some parents think loaning money to the kids will result in a win/win: the kids get a lower monthly payment, and mom and dad get higher interest on their money than what is offered on their bank savings.  Additionally, off-the-books family loans can give the bankers the illusion the kids are in better financial shape than they really are, so they may be more willing to lend the kids money for homes, cars, and businesses.

Plan-to-make-student-loans-more-forgiving-T3H4AHH-x-largeAs a general rule, I think loaning money to family and friends is a bad idea; it changes the relationship from parent/child to lender/borrower.  I have observed many hurt feelings and strained relationships when parents have loaned money to their kids; therefore, I don’t recommend it. Under absolutely no circumstances should parents ever lend money to their children they can’t afford to lose!  Retirement can turn into a real nightmare if you depend on your kids to pay you back and they don’t. Not only will your relationship be estranged, but you could end up destitute in the process.

Completely pay off the loans  

It is certainly a better option to pay off your children’s student loans than it is to lend them the money with expectations of being repaid. Gifts don’t negatively affect relationships the same way loans do, especially if the gifts were made with no strings attached. There are a few things to consider if you pursue this option. First of all, if you have multiple children, there may be hurt feelings if one child gets a big financial gift for going into debt, but the other siblings get nothing for avoiding debt.

I have seen many strained relationships when mom and dad bail out the struggling child and offer no similar gifts to their other children.  If you can afford it, you may consider giving comparable sized gifts to the other children, even if they don’t need it.  This will help alleviate any perceptions of favoritism.

Secondly, the Internal Revenue Service considers a student loan payoff a gift to your children if the payment is larger than $14,000 a year ($28,000 for married couples filing jointly). Before you make any gift greater than $14,000 to any individual, be sure to check with your tax advisor to ensure you report the gift correctly.

 Unlike older parents, adult children often have decades to recover from a financial setback.

Finally, if your gift will reduce the amount of your own retirement savings to the point it negatively impacts your retirement income, don’t pay off the student loans.  Parents often look at their retirement savings as “lazy money” that the kids can certainly use now; however, taking out a large sum from retirement savings may increase your tax obligation the year of withdrawal, and it may decrease the amount of income you will enjoy in the future.  A good rule of thumb is to make sure mom and dad are financially secure before helping out adult children.  Unlike older parents, adult children often have decades to recover from a financial setback.

Partner with the payments 

One idea I think has some real merit is to agree to match the child dollar for dollar for every monthly payment the child pays towards their student loans above the monthly minimum. Here’s how this would work:  On a $30,000 student loan at 7% interest payable over 20 years, the monthly payment would be $232.59/month.  If the child were to pay $332.59/month (an graduation-with-parentsextra $100), mom and dad would match the payment by $100 for a total payment of $432.59.

Under this scenario, the loan is shortened to 7.5 years from 20 years, at a savings of over $17,000 in interest, and the cost to mom and dad is only $8,900 spread out over 7.5 years.  In this process, the child learns a valuable lesson about paying off loans: extra payments equal extra savings; and, if the child isn’t interested in paying off the loan quicker, then why should the parents?  To ensure the payments are actually being applied to the loan, parents can require the child to periodically present a copy of the loan statement.

Every family situation is different, and what might work with one family may be a disaster for another; but one thing is for certain: husbands and wives should be of one mind.  Parents who secretly bail out their adult children without the blessing of their spouses are asking for trouble; therefore, any parental decision about paying off student loans should be made jointly or not at all.