How Do Parents Pay for College Without Financial Ruin?

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Thinking about your child’s education? You’re probably wondering how parents pay for college. From cosigning a student loan to refinancing a mortgage, there are many ways to help your child achieve their academic dreams.

However, parents shouldn’t sacrifice their own financial futures to do so.

The earlier you start financial planning for college, the better off you (and your child) will be. If you didn’t start saving when your son or daughter was a baby, don’t worry, there are other ways to give them financial support.

Here are seven strategies to consider for parents looking to pay for college:

1. Create a college savings plan
2. Apply for PLUS and private loans
3. Cosign student loans
4. Tap into retirement plans
5. Use home equity loans
6. Review inheritances and encourage gift giving
7. Teach them valuable money lessons
● Plus: Be sure to consider all your options for paying for college

1. Create a college savings plan

One of the first steps you can take is to anticipate that your child will need help paying for college. Whether you have one year or 18 years before they head out, setting up a college savings plan can help you get ahead of the game.

A popular way to save is through a qualified tuition program, or 529 college savings plan. According to the U.S. Securities and Exchange Commission, all 50 states and the District of Columbia sponsor at least one type of 529 plan, prepaid tuition plans or college savings plans.

However, each state has different rules and benefits attached to its state-sponsored college savings plans. So be sure to read up on what your state offers and how your savings could add up over time.

Unlike other savings plans, 529 plans have high contribution levels that allow you to put away more money for your child’s education. Plus, the long-term investment options provide a way for the account to potentially grow at a faster rate.

When you’re ready to help pay for college, you can withdraw money for tuition and school-related expenses, such as college textbooks and housing, without penalty. And the money you take out isn’t taxed.

2. Apply for PLUS and private loans

Right now, 3.6 million parent borrowers have parent PLUS loans to help their children pay for college. You can apply for a parent PLUS loan by using the Free Application for Federal Student Aid (FAFSA).

PLUS loan holders can borrow an amount that’s as high as the cost of tuition. And the loan is treated like any other federal student loan, with a few exceptions.

One exception is that your student loan bill comes as soon as your loans are fully distributed (though you can request a deferment while your child is enrolled). Another is that you might not qualify for forgiveness programs offered for traditional student loans. However, there are ways to lower your PLUS loan payments to a more manageable level.

Parent PLUS loans also come with a fixed rate of 5.30% for the 2020-2021 school year, which is the highest rate charged for federal loans. If you might not qualify for parent PLUS loans — or if you can get a lower interest rate elsewhere — there’s also the option of going through private lenders and banks.

How parents can pay for college using private student loans

Private student loan rates can be lower than federal loan rates if you have good credit (usually a score of at least 670, according to credit agency Experian) and an income that allows you to handle the monthly payments with ease. Each lender has its own requirements, though, so it’s important to do your research and shop around.

You might also be able to access other features and terms through private loans. When you apply for private loans as a parent, make sure you understand the implications and compare your options.

The reality is a parent PLUS loan isn’t always the way to go, so get quotes from different lenders and compare them to PLUS loans before you decide.

Considering a private student loan for parents?
Check out these 5 Great Student Loans for Parents in 2021

3. Cosign student loans

If a student needs to supplement their federal student loans, they often turn to private student loans as an option. However, these loans require an extensive credit history and a good credit score, which many students don’t have yet.

That’s where parents come in. When you decide to offer help paying for college, you should consider the pros and cons of cosigning a student loan.

When you cosign a private student loan, you essentially assume liability for the loan if your child is unable to repay it. While your child benefits, you take on a potentially big risk.

Becoming a cosigner on a student loan should be done with careful consideration. Take into account your student’s financial goals and history of financial responsibility before you cosign a student loan for them. And figure out what it will take to be released as a cosigner on the student loan.

4. Tap into retirement plans

According to a 2020 study from Sallie Mae and Ipsos Public Affairs, 44% of a student’s costs for college were covered by parent income and savings, and 82% of parents interviewed for the study stated that they were willing to “stretch themselves financially” to pay for college.

Where does this money come from? In some cases, it might come from retirement plans. If you can afford it, using your retirement funds can be an easy way to provide help paying for college.

How parents can pay for college using IRAs or 401(k) plans

For parents or grandparents under the age of 59 and a half, early withdrawal penalties, normally 10%, on IRA accounts don’t occur if you’re using the money to help pay for college.

However, you may still owe income tax to the IRS on the distribution amount, depending on the type of IRA used, and other factors. Consult a tax professional to get the best information possible.

If you don’t have access to an IRA, you might be able to apply for a 401(k) loan. Most of these loans have five-year terms, and the interest you pay goes back into your retirement account. With a 401(k) loan, you can borrow half the vested balance or up to $50,000, whichever amount is smaller.

It’s important to consider how using retirement funds in the short term might impact long-term financial goals. If you take out a loan, you’ll miss the time your money could be in the market. Plus, if you withdraw the money, you’ll have to save even more later to make up for it.

Remember: There are loans for college. There aren’t loans for retirement. You might be better off getting a loan, instead of borrowing from your retirement accounts, to help your child pay for college. Carefully run the numbers before putting your retirement at risk.

5. Use home equity loans

Putting up your home as collateral to help pay for college might sound extreme. But if interest rates are favorable, it could be an option worth pursuing — although it’s not a risk-free endeavor.

Using a home equity loan to avoid student debt comes with two big risks: You could end up owing more on your mortgage than your home is worth, and if you run into trouble paying back your home equity loan, it could result in losing your house.

Another potential issue is that the money received from a home equity loan may be taken into consideration when the federal government or school awards financial aid, making it harder for your child to qualify.

In addition, with the passage of the Tax Cuts and Jobs Act, you can no longer deduct interest on a home equity loan to pay for college.

The upside of home equity loans? Some home equity loans could offer lower interest rates than private student loans, especially if you have good credit. You may also be able to borrow more than a traditional student loan allows, and the home equity loan terms might be longer than other kinds of loans.

6. Review inheritances and encourage gift giving

When a loved one dies and gifts money to a family member or friend, it’s often with the intention that they’ll use it for a worthwhile purpose.

However, they might set up an inheritance so a child is unable to access the funds until they’ve reached a certain age, which could be well after college.

Consider contacting an attorney who can help you understand the terms of your child’s inheritance. You should review any hardship clauses your child might qualify for. Avoid inheritance loans or advances, given their high interest rates and risky terms.

Gift giving as tuition assistance

You could reach out to living relatives and friends who might be willing to give to an education fund. Encourage grandparents, aunts and uncles to forgo traditional birthday and holiday gifts in exchange for tuition assistance.

Set up a college savings plan, Roth IRA or traditional savings account (for current students) where relatives and friends can deposit funds safely.

But realize that some of these assets, especially if they’re in your child’s name, can impact their ability to qualify for financial aid.

7. Teach them valuable money lessons

Finally, remember that paying for college isn’t an obligation for every parent.

If your finances don’t allow for it, be open and honest with your child about your inability to offer help paying for college.

Instead, encourage your child to seek scholarships, applying for on- and off-campus jobs or researching alternatives to pricey schools. As a parent, you can play an important role in the process without having to sacrifice your own money and savings.

Parents, consider all your options for paying for college

Tuition costs continue to rise, and funding options remain limited. Parents who want to offer their child help paying for college have many questions to ask themselves.

Whether you’re considering low-risk options, such as parent PLUS loans, or riskier options like home equity loans, research the pros and cons before you decide how to fund your student’s college education.

Andrew Pentis , Maya Dollarhide and Miranda Marquit contributed to this article.

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