Eight tips for avoiding overwhelming student loan debt

As a financial advisor, I frequently see families take on huge amounts of debt to pay for a child’s college education. In many cases, the debt becomes a long-term financial burden for students — and sometimes their parents, too.

With proper planning, this needn’t be the case. Here are some tips to help you plan college financing so your children can avoid excessive student loan debt and you can avoid disrupting your financial plans.

1. Start saving early

Accumulating significant savings to pay for college is not as hard as it sounds, but it requires a firm commitment early on. If your kids are still young, start saving today; you’ll be in a strong position financially when they reach college age, and they may be able to avoid student loan debt entirely.

Parents who start saving $250 a month in a child’s college fund at birth and increase their contribution by 3% each year could accumulate $134,000 by the time the child enters college, assuming an annual average investment return of 7%. That would be nearly enough to pay the average cost for four years of state college tuition, fees, room and board, assuming that today’s cost (about $80,000) also increases at nearly 3% per year. It also would be enough to put a serious dent in the cost of a private college.

2. Set a budget and stick to it

According to a recent survey from Discover Financial Services, a provider of credit card, banking and loan services, fewer than half of parents said they were limiting their children’s choice of college based on price. But it’s important to be realistic about what you can afford and to discuss it with your children well before they start applying to colleges. Once you set a limit for what you can handle, your children can still apply to schools that are out of your price range — but with the understanding that they would also need to receive merit aid to attend.

3. Avoid private loans

Only 30% of the Discover survey respondents considered themselves very knowledgeable about the differences between federal and private student loans. But it’s important to understand the key ways in which these two types of loans will affect your student’s finances after graduation

Unless your family has the resources to pay for the entire cost of college out of savings and current cash flow, you should file a Free Application for Federal Student Aid, or FAFSA. No matter how much money parents make, students will qualify at a minimum for unsubsidized federal Stafford loans, and the FAFSA is key to unlocking those funds. Unsubsidized loans carry the same interest rate and terms as subsidized government loans, but interest will accrue while the student is in school.

Students should always tap out federal loans before taking out private loans, because they provide much more lenient repayment terms, including the opportunity for deferments, extended terms and income-based repayment schedules. Private student loans usually offer little flexibility in repayment terms.

Private loans also often require parents to co-sign. This can be a bad idea. Co-signing puts parents on the hook for the entire loan balance if the student can’t pay the loan. While students have a lifetime of income to make payments, parents may have only a few working years remaining and often cannot afford this type of long-term financial commitment. Students should resort to private loans only after they have exhausted all other sources of funding and only after they have carefully considered the long-term implications of that debt.

4. Develop an aid strategy

Families with greater need may qualify for subsidized federal loans and work-study programs, which can help defray some of the cost. While only the neediest families will qualify for federal government grants, many schools may offer grants, scholarships or special loan packages based on a student’s financial need. (Note: Some private schools require students to file an additional form to apply for need-based funds from the institution.)

Many students also find that with the help of merit aid, in the form of grants or scholarship money, the cost of some private schools is not much more than the cost of a state school. Schools offer this money to the students they most want to attract, which means the top third of candidates will likely receive much better offers than the bottom third. To maximize your children’s chance of landing a good merit aid package, focus on schools for which they are slightly overqualified.

5. Make a college spending plan

As your children get closer to attending college, plan where the money will come from for each year of school. Look at how much you can pay for with regular cash flow; how much is available from savings and investments, financial aid, loans and work-study awards; and how much your students will be able to contribute from part-time jobs. What if your children need a fifth year to graduate or require postgraduate education to achieve their goals? Where will that money come from?

Also consider how much debt will accumulate over the course of your children’s higher education. It’s important to think realistically about the impact that debt will have on them. If they won’t be able to cover student loan payments, based on their expected income after graduation, you may need to consider a lower-cost strategy.

6. Don’t derail retirement planning

If you have been saving aggressively in your employer-sponsored 401(k) and your retirement plan is on track, you might consider borrowing from your employer plan. This would allow you to tap your retirement funds without incurring taxes or penalties. Typically, you must repay the loans over five years through payroll deductions. This may seem like a good idea because you pay yourself back with interest, but be careful. If you leave your employer, you usually have to repay in full or the IRS will treat any unpaid balance as an early distribution, with income tax and early distribution penalties if you are younger than 59½.

In my practice, I find that many parents either borrow money themselves, through parent PLUS loans or home equity lines of credit, or assume all or part of their kids’ debt burden after graduation. You might be able to afford the debt payments today, but will that still be the case after you retire? And if you are behind in retirement savings, taking on debt to pay for your children’s education may prevent you from having the cash flow you need to catch up during these all-important final working years.

Parents should be very cautious about taking on debt or tapping retirement savings to help their children pay for college. Remember, thinking of your own needs is not being selfish. Attending a less expensive school won’t ruin your child’s life, but taking on too much debt and not saving sufficiently for retirement late in your career could irreparably damage your future financial life.

7. Help your kids understand debt

I find that soon-to-be college students have no idea how student loan debt will affect their finances. Too often, the resulting college degree doesn’t increase the students’ income potential enough for them to easily cover student loan payments. But kids have little experience with budgeting a monthly income and therefore no basis on which to make rational decisions regarding student loan debt.

By working with your children on a realistic budget based on their expected earnings after college, you can help them begin to understand how debt will figure into their financial future. That doesn’t necessarily mean you should let your children make the decision alone about how much debt to take on.

8. Consider a community college

This is probably the single most effective way to reduce the total cost of a college education. Kids often chafe at the idea, but if the money isn’t there, they will be far better off with two years of community college than borrowing heavily in their freshman and sophomore years. In most states, students with good grades can transfer to a state school to complete a four-year degree.

In the long run, your students’ future financial position is much more important than senior-year bragging rights. True, your children may not have the typical college living experience for the first couple of years of their higher education, but I guarantee there will be plenty of time for raucous parties later on.

Next steps

If you need help creating a financial plan for college, consider working with a financial advisor. An advisor can offer college-planning tools to help you clarify college finances. Your advisor can help you determine how this expense may fit into your retirement plan while also helping your child avoid taking on overwhelming amounts of debt.

James Kinney is a certified financial planner and the founder of Financial Pathway Advisors in New Jersey. This article first appeared at NerdWallet. Learn more about James at NerdWallet’s Ask an Advisor.