Your student has probably made a college choice or is down to the final few and now you are wondering either how am I going to fund this or is there a better way.
You have reviewed your resources, free cash flow, scholarships, and grant options. And you discover you still haven’t covered all the costs or you do not want to use all your college funds now since your student has graduate school in their sights.
So like most, you have a funding gap and need the smartest solutions. This is where smart student loans planning and other advanced strategies come to play.
Here is a quick playbook and some detail on some different ideas.
Use student federal loans first.
Students have a certain dollar amount in federal loans they can borrow each year: $5,500 freshmen year, $6,500 sophomore year, $7,500 junior & senior year. Now, say you’ve also maxed out the federal student loan funds available.
Why do we like these loans first?
These loans do not require a co-signer, offer reasonable interest rates, flexible repayment options, build the student’s credit and don’t jeopardize the parent’s savings and retirement. Additionally, using repayment options after graduation can provide a more efficient planning option. (This blog has a six step plan that incorporates using the federal student loan each year.)
Still have a funding gap?
After student federal loans are maxed out, do you still have a funding gap? What options remain? Private loans, Parent PLUS loans from the government, home equity loans, or loans on retirement plans are all places you can look to cover this gap.
Before we cover these options, we want to stress the importance of using any of these to fund a smaller gap or are part of a longer term plan. Parents have two primary loan options to explore first: Parent PLUS and private parent student loans.
Interest Rates & Loan Fees
One of several key difference between the two is interest rate. Finding the best rate for you will depend on your credit rating but your rating is not considered when setting the rate. The Parent PLUS loan is a fixed interest rate of 7% for the life of the loan (as of 7/1/17 to 7/1/18). This relatively high rate is based on a group credit rating similar to group health rates at your employer.
If you have a better credit rating, your interest rate through a private lender may be much lower than 7%. Rates could be as low as 3%. Another great difference, is the opportunity for you as a co-signer to be removed in the future.
Is it a fixed rate?
Private loan interest rates may be fixed or variable. The PLUS rate is fixed and while higher will not change throughout the life of the loan.
Are there origination fees?
For PLUS loans, a loan fee of 4.264% will be deducted from the loan disbursement amount (as of 10/1/17 to 10/1/18). For private loans, any applicable fee depends on the lender so read the terms carefully.
Another key difference between PLUS and private loans is repayment options. Private loans will typically offer different terms like 10, 15, or 20 years. PLUS loan repayment plans include the standard 10 years as well as Graduated and Extended plan options. The Graduated plan payments are lower at first and then gradually increase of the life of the loan (usually 10 years). The Extended plan allows for either fixed or graduated payments but increases the term up to 25 years.
Unless you request deferment of student loan payments, you will start being billed soon after disbursement of the funds (often in 60 days). With PLUS loans, you can elect to defer payment until after the student graduates from college. Interest continues to accrue during that time.
With private loans, they may have more available options. You could start making payments in 60 days, or you could choose to make interest only payments while the student is in college, paying a fixed amount like $25 per month until they graduate, or deferring payments all together until after graduation. Unpaid interest will accrue.
We always recommend parents do not take out private loans in their own names if possible. We would suggest that having the student take out the loan in their name but in most cases the lender will require the parent as a co-signers.
Parents need to realize that co-signing the loan makes them just as liable for the payments as their student. Those loans will appear on the parent’s credit report as well. Please understand the impact if you are looking to make a major purchase in the next four years or you already have a lot of debt.
Another important note, Parent PLUS loans are 100% in the parent’s name and sometimes parents think they’ll be able to transfer this loan to the student after the student graduates. Unfortunately, this information is not true. The parent is the borrower for the life of the loan.
What happens if a parent or student dies? With a PLUS loan if the parent or student dies, the loan is discharged or forgiven. With a private loan, that is not necessarily the case. It depends on the lender.
How do I apply?
To obtain PLUS loans, parents complete the FAFSA each year, and the school will direct you on how to setup the PLUS loan.
To obtain private loans, a good place to start is with your college’s financial aid office. They may have preferred lenders they recommend. Other potential options like www.studentloanhero.com or www.simpletuition.com can be a good starting point to find and compare lender information.
If you are a member of a local credit union, you can find favorable rates for student loans most of the time.
What About Home Equity and Loans on Retirement?
With the current changes to the tax code, using home equity had changed significantly. The benefit of using a second mortgage or home equity line of credit before the 2018 provide the opportunity to write off the interest (unless you were subject to AMT and to be technical it was part of original indebtedness). Under the new code, you are no longer allowed to take this write off. However, the proper mortgage structure allows for a better way to pay.
Given the low interest rate environment, home mortgage interest rates will be lower than private student loans. Home mortgage interest and student loan interest are both tax deductible. However, student loan interest is capped at $2,500 (vs. a primary mortgage now capped at $750,000), and your to write off student loan interest your modified adjusted gross income cannot be more than $80,000 (or $160,000 for married couples filing jointly).
Borrowing from your retirement plan has very little upside and you should consider every other option before taking a loan. Money taken out of your plan is not earning for you because it is not in the market. Money from your 401k typically must be paid back within 5 years—not a very long term compared to other loan options.
Don’t jeopardize your retirement to send your children to school since there are many alternative options for lowering the costs of education.
What should you do?
Be careful, be smart and get advice if you need it. There is no limit to how much a parent can borrow so long as it does not exceed the cost which can create a dangerous situation indeed when college can cost up to $70,000 per year.
By carefully considering your costs before applying, you can eliminate a lot of the problems outlined above.
Our advice: Choose a college you can afford, plan out how you’ll cover all four years of the costs down to the penny, and use loans wisely to cover small gaps.
Need help? Let’s Connect – we are here for you!
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