Mo Vidwans
Last month, we discussed scholarships, funds, tax credits and other ways of reducing the impact of tuition fees for the education of our children. The focus there was to create funds for the facilitation of the education. This month I would like to review the same issue but from a different perspective. If, at all, we have to borrow funds for the education of our children, what would be the best way of doing it so that we don’t overburden ourselves unnecessarily?
Federal student loans (FAFSA) have long been a viable option and indeed many parents/students go for that option since it is most available and readily accessible, albeit after filling in a lot of paperwork. Parents/students have to establish, in this process, that they would be able to repay the loan within a reasonable time. Not a good assumption because about 10 percent of the loan receivers struggle with the repayment plan. The annual interest rate for many of these Government loans ranges from 5 to 7 percent which is high by today’s standard.
Private student loans can be pricier with rates determined by the borrowers’ credit score. Most college loans can be relatively expensive when also compared with other loans.
Consequently, many families are turning to relatively unconventional methods.
Home Equity
Using the equity that you may already have built into your home would be a good way to fund your children’s education. It does help if you have lived in that home for a few years because that allows you, in addition to the 20 percent down payment, to tap more equity from the home. It can be relatively cheap compared to many other options. The interest rates on home-equity and line of credit average about 6 percent and 5 percent respectively according to bankrate.com. If you have good credit score it could go down a bit too.
And that is before the tax breaks we can get on these interests. Homeowners who itemize on their tax returns can take the deductions for the interest on home equity loan (up to $100,000 used for any purpose including college). Obviously, higher the income tax bracket one is in, higher the benefit of the tax break. A word of caution, if you know you are subject to alternative minimum tax (AMT) then the home equity interest deduction is allowed only when the loan is used for home improvement.
Traditional equity loans charge a fixed rate generally and you get the whole amount in one check where as the lines of credit can charge variable rate but you borrow only what you need and when you need it; allowing you to avoid paying interest on the money you don’t need at that moment.
Homeowners can also refinance their mortgage, especially when they have enough equity built into the home, and use the freed-up equity money for education purposes. The total interest paid on the new mortgage goes up. It should also be pointed out that such borrowing would affect your financial aid package.
Credit Cards
This is certainly not my favorite and I discourage my clients from using them but it should be known that this alternative is available especially if used wisely.
Parents who know they can pay off the borrowed money on credit cards, one way or the other, can take advantage of the 0% introductory rate offered when you switch or go for a new card. This benefit will be there generally for up to 10 months. Some banks offer such rate up to 18 months. The key thing here is that parents must have arrangements, like a yearend bonus or extra months’ salary to pay off the debt. The 0% period gives parents more time to create alternate finances; many times there are illiquid assets and it takes time to liquidate them and under these circumstances these credit cards come handy.
Some credit cards allow you to collect reward points which is an added advantage. There is also a downside, which is that some colleges don’t accept credit cards for tuition payments and some charge additional 2 – 3 percent fee if a credit card is used. Even bigger lurking danger is that if the credit card loan is not paid off within the stipulated period then the interest rate can be as high as 18 percent.
Zero interest loans
Some colleges offer zero interest loans to cover a student’s tuition. Colleges with strong endowments are lending money to deserving students for tuition with a very low interest rate, even as low as 0%. They are generally eager to attract good students with such offers and include such a letter in their aid package. Terms vary by school and repayment can be as short as the semester or as long as 10 years. The downside is that families have to show financial need and students have to be deserving, which means having high accomplishments in high school.
Life Insurance
Policyholders of “whole life” policies have death benefit with a tax advantaged investment account and such policyholders can borrow cash from the policies to pay for various expenses including the tuition bills. Interest rates on these loans can be fixed or variable and can typically range from 4 to 5.5% which is lower than most federal or private loans. Like always, there are downsides to this also, so work with a financial planner or accountant to assess this option.
Other Alternatives
There are some start-up companies that offer loans to promising students (future employees) or children of their employees. Others help their employees get loans approved through the regular channels. Many match the employee’s loan payments. This extra help is offered to keep their employees happy and productive or to attract new recruits but nevertheless it does help the borrowers.
One thing for sure: there is no substitute for proper long-term planning for the education and probably the best way is to squirrel away little bit at a time for a long period.
