When considering and applying for student loans, help your child understand the entire process, including the responsibility for repayment, and then look into your best options for financing. The lowest rate student loans with the most flexible terms are from federal loans such as direct loans and Perkins Loans. While these are always the first choices in paying for college, they may not offer enough financing to pay for all college expenses, and parents may need to step into help. Thankfully, there are financing options for parent borrowers to help fill the gap.
If your undergraduate student needs help paying for college expenses, you can assist by taking out a federally backed PLUS loan. An option exclusively for parents, federally backed PLUS loans are a good way to cover remaining tuition and other expenses after exhausting all other financial aid options.
Here is what you need to know about Federal Student Aid's PLUS loans:
- Because the U.S. Department of Education is the lender, you must complete the Free Application for Federal Student Aid (FAFSA) to receive a PLUS loan
- Biological, adoptive and sometimes stepparents of a dependent undergraduate student can take out PLUS loans
- Even though the loan is for your undergraduate student, it’s in your name, and you’re responsible for repaying it. You can’t transfer the loan at a later date to your child.
- You may be denied a PLUS loan if your credit history is poor
- The maximum amount you can borrow is the cost of attendance (as determined by the school) minus any other financial assistance received
- Interest starts to accrue on PLUS loans as soon as the lender issues payment to the college
- A loan origination fee (usually about 4.3 percent of the loan amount) will be deducted from the principal at each payout
- You may start to repay a PLUS loan as soon as the lender releases funds to your child’s school, or you can defer (postpone) payments until after your child graduates. If you choose deferment, interest will still start to accrue as soon as the lender releases the funds.
- You must reapply for a PLUS loan every year
- You may pay off a PLUS loan early without paying a penalty
Private Student Loans
Private student loans from lenders such as credit unions and banks can be a good way to pay for educational expenses not covered by federal loans, scholarships and grants. Here is what you need to know about private student loans:
- Interest rates on private student loans vary, based on your credit history and the loan’s terms
- Most private student loans have variable interest rates, meaning the interest rate—and therefore your monthly payments—can increase or decrease at any time
- Some lenders allow you to postpone making payments or make reduced/interest-only payments while a student is in school. Often, however, payments start as soon as you receive the funds.
- Approval is based on creditworthiness
- Serving as a co-signer on the loan may increase the likelihood of approval for your student and result in a lower interest rate
- You may be able to consolidate private student loans into one lower-interest loan
Outside of loans exclusively for education, using the equity in your home is another way to finance higher education. There are two primary options: a home equity loan (HEL) or a home equity line of credit (HELOC). The main difference between these two types of loans is that you get your money in one lump sum with a HEL and as a line of credit you can access over time with a HELOC. Both can offer a low-cost way to borrow money for higher education, and you can deduct the interest paid on home equity debt of up to $100,000 on your taxes. It’s important to remember that you’re borrowing against your home. By doing this, your home debt grows. And, if you can’t pay the money back, you could actually lose your home.
- Can be taken out in one lump sum
- Interest rate may be lower than other types of loans
- Fixed-interest rate; monthly payments stay the same
- Loan term can span between 5 and 30 years
Certain lenders, including Navy Federal, allow you to borrow up to 100 percent of your home’s equity. If you’re looking to save money, setting up automatic payments may result in an additional discount on the loan rate. Opting for an interest-only version of this loan type may lower monthly payments for a set period of time (around five or six years).
- Revolving balance on line of credit, allowing borrower to use only what is needed
- Line of credit can be used again once the principal is paid off
- Payments may change from month to month, based on the amount borrowed and the variable-interest rate
- Available terms range from less than 5 to more than 20 years
Accessing your funds with a HELOC is easy and can be done via check or credit card. Certain lenders, including Navy Federal, allow you to borrow up to 95 percent of your home’s equity. Some lenders may offer a discount for setting up automatic withdrawal payments. Choosing an interest-only version of this type of loan can keep your monthly payments low for up to 20 years.
Some parents may opt to tap retirement accounts for college expenses. If you use funds from your Individual Retirement Account (IRA) to pay for college expenses, the IRS won’t assess the customary 10 percent penalty fee on the withdrawn funds. With a traditional IRA, you still must pay income tax on the distribution.
If you have a 401(k), TSP or other employer-sponsored savings plan, the rules may allow you to borrow up to half of your account balance or a maximum of $50,000 tax-free. Depending on the rule in your particular 401(k), you may have five years to repay the funds, plus interest, but this can shrink to 60 to 90 days should you resign or lose your job. If you’re unable to repay the loan, the full unpaid balance could be subject to taxes, in addition to a 10 percent federal tax penalty.
These nontraditional financing options also can help fund your child’s college education:
- Intra-family loans: A family member loans you money but charges an interest rate lower than what most banks charge. It’s important to stay within IRS requirements if you go this route.
- Life insurance policies: Whole life, variable life and universal life insurance policies all have a cash value component that you can borrow against. Interest rates generally range from five to nine percent annually. As the owner of the policy, you determine when to repay the loan. However, unpaid interest charges can undermine the policy’s cash value and potentially cancel it out.
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