This past week we were contacted by an advisor seeking information about our CSLP course. The advisor wanted to know what sort of information was covered and how it could translate to advice delivered to clients.
The advisor came to us because one of their firm’s best clients, an M.D., had parents in their 70s with student loans for their children. While the parent wasn’t a client of the firm, the advisor was asked if he would examine the recommendations given to them.
Here is the background of their student debt:
- Student debt: $125,000 FFEL Consolidated Parent PLUS loans for their son and daughters undergraduate degrees more than 20 years ago in Dad’s name.
- Standard 10-year payment of $1,549
- Currently in default
- Living on a fixed income (social security & her pension as a school teacher)
- His income is $1,100/mo (Social Security)
- Just received notice that the Department of Education was going to proceed with garnishment of social security
- Her income is $1,250/mo (Social Security) + $1,525/mo (pension)
- Mortgage $100,000 @ 5.7% with 7 years remaining (15 year refinanced)
- Monthly payment of $699.23/mo
- Home Value: $850,000
Bad advice given by a financial advisor
The advisor was surprised to find out that his clients who were in the 70s had student loans. He admitted that he didn’t know much about student loan repayment.
The client's student loans represented more than 50% of their take-home income. It was initially suggested that they could benefit from a mortgage refinance to free up cash flow but the defaulted student loans might prevent that due to poor credit.
Later, the advisor suggested a cash-out refinance from their home to pay off the student debt. Then they could potentially secure a lower interest rate on the debt. He was unsure of the interest because their credit was in the 600s due to the student debt and low income.
Next, the advisor suggested contacting their loan holder to determine if they could negotiate a lower pay off amount for the federal loans. The words were “Usually lenders will take pennies on the dollars to settle a debt like this”. Wrong again.
The advisor added "Since these loans are you children’s loans they are responsible for paying them back. If you die they will have to repay the loans anyway and they are in a better position to refinance the debt than you two are." Finally, the advisor recommended that the children explore where they can take out loans in their names to take under better terms. He felt "they should be able to get a rate in the 2-3% range as seen on TV. "
Of the three options listed the advisor's preferred options was the third, for their kids to take on the debt. This is what prompted the client to contact his financial advisor and that advisor to learn more about this topic.
Sadly, we suspect that there are more stories like this of bad advise given by uninformed advisors who don't take student debt issues seriously. There are widespread assumptions that are incorrect and can be damaging to clients who trust that financial advisors are up to date on student loan programs.
Summary of Advisor's Errors
So let's walk through the mistakes this advisor made and it's negative impact on the parents with loans and potentially on their children.
Bad advice #1 - Settle It
The first recommendation to negotiate with the federal student loan is a dead end. The federal government doesn’t settle student loans. While this could be a possibility for private loans, it is not with the feds. Perhaps the advisor might have mistaken their FFEL loan for a private loan but in this case, settlement is not an option.
Bad Advice #2 - Debt swap - unsecured for secured
A cash-out refinance has been a strategy for borrowers looking for more favorable repayment terms. In December of 2018, Fannie Mae changes some of their regulations for conforming mortgage refinance with regards to student loan debt. One change was to allow borrowers to pay off student loans directly with a cash out refinance. However, in doing so, a borrower is swapping unsecured debt for a secured debt. If the clients can’t afford the payment in their budget putting the home on the hook for the debt could just compound the problem as the couple could end up losing their home.
Bad Advice #3 - Diverting debt to children
This was possibly the most damaging advice. By moving the debt to the children under the assumption that they will get it regardless at the parents debt is incorrect and may negatively impact them many years.
Federal student loans, whether Parent loans or not, are forgiven at the death of the borrower and would not become the responsibility of the kids. Further, since the tax reform act in 2018, the discharge of student debt for the death of a borrower is no longer subject to income tax, so the estate or living spouse wouldn’t even have any phantom tax concerns from the discharged debt due to death.
The Best Advice Should Have Been Quite Simple:
Had either advisor completed the CSLP core course and passed the exam, the client outcome would have been easy to identify and explain to the clients.
Based on the current facts, the proper guidance would have assisted the parent borrowers in reducing their payment to $0. Also, their student loans and would be positioned to have all the principal debt and accumulated interest forgiven at their death, or after 25 years, whichever came first.
The CSLP Program is an essential part of training for financial advisors
Understanding the intricacies of student loan repayment can have a great impact on advice rendered and net affect to finances of borrowers and their families. Had the parent borrowers and their kids taken the advice of the advisor, they would have needlessly transferred more than $100,000 of debt to the children and those debt payments would have come at a cost of other personal or financial goals.
Get our Financial Advisor Guide to Student Loans
Find out more about how you can avoid critical mistakes and liability. Get our guide to the student loan market and how you can address it through the knowledge gained in the CSLP Course.