When looking at and applying for student loan options, help your child understand the entire process, including eligibility and the need for repayment. Then look into your best options for financing. The lowest rates with the most flexible repayment options are available from federal student loans, such as direct loans and Perkins Loans. While these are always the first choices in paying for college, they may not offer enough money to pay for all of a child’s education, and parents may need to step in to help. Thankfully, there are options for parent borrowers to fill the gap.
Parent PLUS Loans
If your undergrad student needs help paying for college expenses, you can assist by taking out a PLUS loan backed by the federal government. Federal parent PLUS loans are a good way to cover remaining tuition and other expenses after using up all other financial aid options.
Here’s 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 student, it’s in your name, and you’re responsible for loan payments. You can’t transfer the loan to your child unless you refinance in his or her name.
- There will be a credit check, and you may be denied a PLUS loan if your credit score is poor.
- The most you can borrow is the cost of attendance (as determined by the school) minus any other financial aid received.
- Interest starts to accrue on PLUS loans at disbursement, or 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) loan repayment 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 to the PLUS loan program every year.
- There’s no prepayment penalty if you pay off a PLUS loan early.
- Parent PLUS loans can be refinanced, which could mean savings if rates go down in the future.
Private Student Loans
Private student loans from lenders such as credit unions and banks can be a good way to pay for school expenses not covered by federal loans, scholarships and grants. Here’s what you need to know about private lenders:
- Interest rates on private student loans vary, based on your credit history and the loan’s terms.
- Adverse or limited credit history could affect your ability to qualify, your loan rate or your need for a co-signer.
- Most private student loans have variable 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.
- Serving as a co-signer on the loan may increase the odds of approval for your student and result in a lower interest rate.
- Once your student has graduated or has started making payments, they may be able to combine private student loans and refinance them into one lower-interest loan.
Outside of loans meant just for school, using the equity in your home is another way to finance higher education. There are 2 primary options for loan borrowers: a fixed equity loan (FEL) 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 an FEL 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. It’s important to remember that you’re borrowing against your home, though. By doing this, your home debt grows. And, if you can’t pay the money back, you could 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
- Life of the loan can span between 5 and 30 years
Certain lenders, including Navy Federal Credit Union, allow you to borrow up to 100% of your home’s equity. If you’re looking to save money, enrollment in automatic payments may result in an additional interest rate reduction. Opting for an interest-only repayment plan may lower monthly payments for a set period (around 5 or 6 years).
- Revolving balance on a line of credit allowing borrower to use only what’s 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% of your home’s equity. Some lenders may offer a discount for setting up automatic 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 usual 10% penalty 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 5 years to repay the funds, plus interest, but this can shrink to 60 to 90 days should you quit 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% 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 5 to 9% annually. As the owner of the policy, you determine the repayment terms. However, unpaid interest charges can undermine the policy’s cash value and potentially cancel it out.
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.