The rapid acceleration in student loan debt is being treated like some mysterious economic crisis that demands a white knight to ride in and save the day. The fact is, the cost of college is a lifestyle expense that has grown disproportionally compared to houses and cars. And parents—thinking with their hearts and not their wallets—are making reckless decisions with regard to how they pay the constantly rising college costs because there is no gatekeeper in the college purchase process.
Financial advisors need to become that gatekeeper.
With the cost of college resembling the purchase of a second home or a fleet of cars, it’s time for financial advisors to recognize that the role of traditional savings programs geared toward education (529 Plans, ESAs, UTMAs, Roth IRAs, etc.) is to save for the down payment on college (that magical 20–25 percent for each bachelor’s degree being purchased) and adopt a financing framework for funding college that is more akin to a mortgage.
We need to “pre-qualify” the family and each of their college-bound students for college. Financial advisors need to take their clients through an underwriting process to determine just how much college they can finance so families can maintain their current lifestyle, stay on track for retirement and put their kids through school.
College is a cash flow challenge, not a savings or investment exercise. Financial advisors need a different mindset, skill set and problem-solving approach if we are going to serve the parents of college-bound kids effectively. Our instincts have conditioned us to build an asset base for future expenses but the rapidly rising cost of college has left most parents too far behind for that approach to solve the college funding challenge—especially if there is more than one student to educate.
Financial advisors need to come to terms with the idea that Mom and Dad need to finance college and fund retirement. Families routinely finance other major purchases—namely the house and the cars—and are completely comfortable with the idea that they aren’t going to pay 100 percent of the entire cost upfront; parents make a down payment and finance the rest, making monthly payments over long periods of time along the way so they can direct something toward investments for the future.
Given the cost of college, parents are better off continuing to set aside funds for their retirement and finance the increasing cost of higher education by using cash flow efficient payment options over time. But this is not how families—or their advisors—are approaching the cost of college. And the financial aid system does not provide the guard rails of traditional lending; there isn’t even a data field in the FAFSA or CSS Profile that asks for information related to liabilities in the student’s household (other than mortgage debt reported only on the CSS Profile).
Once our industry paradigm shifts toward financing most of college, the focus should move toward the most efficient financing options available for the household. Interest-only collateralized loans that allow parents to “rent” cash flow on the cheap becomes very attractive—home equity lines of credit, margin loans on investment accounts, loans that leverage cash value in permanent life insurance policies, low interest student loans, even competitively priced private loans come into focus as potential sources for financing higher education.
As counter intuitive as this may seem, a detailed cash flow analysis driven by the “before, during and after” related to college reveals this approach makes sense in the context of maintaining current lifestyle and staying on track for retirement while funding college—all kids, all years. Remember, parents are literally purchasing the equivalent of another house so implementing an attractive, long-term financing strategy that is cash-flow friendly makes sense.
Imagine calculating the family’s debt-to-income ratio (DTI) and using the same guidelines any lending underwriter would to determine the maximum amount of money the family should borrow. When consumers buy a house, lenders use a magical 28 percent front-end (housing ratio = mortgage + taxes + insurance + HOAs), and 36 percent back-end (credit card bills + car loan payments + student loan payments + child support + all other liabilities) range to determine the amount of money they will “pre-approve.” The documentation to arrive at these numbers is painful but the math is not.