After your child has maxed out all of their financial aid and there is still a shortfall you may want to consider the following four options:
1) Home Equity Loan or Refinance
2) PLUS Loan
3) Non-Profit Loan
4) Private Loan
When you fail to fund your Kid’s
Education--and financial aid is not enough--you may have to go into debt in
order to fund your Child’s education.
College Costs & Inflation
As you are probably aware tuition hikes have been higher than inflation over the past several decades. Private college costs now exceed $36,000 annually and in-state costs at public colleges now exceed $16,000 as of September 2011, according to the College Board.
When you consider inflation--if you started saving for your infant you would be looking at well over $160,000 in in-state tuition.
You could possibly pay less if you were to obtain a grant, scholarship and/or tax breaks. If you still had a shortfall you would have to take out loans to cover the remaining college costs.
If you failed to properly save—or didn’t save at all for your child you should give the following borrowing options strong consideration
1) HEL (Home Equity Loan) or Refinance
A Home Equity Loan normally has a variable rate and you can deduct up to $100,000 on your tax return.
A cash out Refinance would be at a fixed rate, however you would have higher closing costs and by doing a refinance you could reduce the grant aid that your child would be eligible for. As with the HEL the interest as a result of the refinance would be tax deductible.
The key benefit of a HEL or Refinance is that it is often the best option after you consider the tax write-off—however, you will put your house at more risk for loss. Therefore, make sure you can responsibly pay back the amount borrowed or refinanced.
2) PLUS Loan (Parents Loan for Undergraduate Students)
The Plus Loan is a federal loan with a fixed interest rate that can be paid back over a number of years. There are additional” fees” that can increase the interest rate.
There are also “credits” that can help reduce the rate (automatic debit and timely payments by almost a full percentage) some.
You also have flexible payment
options if you were to lose your job. A Plus Loan also offers deferral of
repayment while your child is in school. The loan is often at a high interest
rate but has flexible terms and minimal credit check requirements.
Non Profit Loan
Many State-sponsored nonprofit agencies offer fixed-rate loans that are in many cases lower than that of the PLUS Loan.
Lenders in some states will transfer the loan to your child if they have good credit.
The key benefit of a non-profit loan is that it can often be 1% to 2% lower than that of the PLUS loan.
You can go to google to find out if non-profit agencies offer loans in your state.
4) Private Loan
Most Private Loans have a variable rate structure and the better your credit—the better the rate that you would receive.
Many Private Lenders will allow you to transfer the loan to your child if they have good credit.
The better your credit the lower the
initial interest rate will be, however always remember that the loan has a
variable rate feature and is subject to adjustment.
Other Concerns That You May Have
If you have not properly saved for your or your child’s education you may be forced to choose from the above options.
If the time horizon for your or your child’s education funding is well into the future you may be able to start saving now to alleviate or eliminate your need to borrow in the future.
At any rate, consider among the options and choose the one that is most appropriate for you and your family.
Also, keep in mind there are other
means of funding your or your child’s college funding shortfall. What we have
discussed here are the most common that are available to the largest number of
Savings Methods To Avoid Or Reduce An Education Funding Shortfall
With inflation and education expenses consistently rising over the past few decades it can often be difficult for you to save enough to cover your or your child's total college expenses.
If you can save 1/4th to 1/2 of the cost you may be able to use your current income and grants and possibly avoid the need to take out a Home Equity Loan, Refinance, PLUS, Non-Profit or Private Loan.
To calculate your or your child's
future costs go to www.finaid.org/calculators and click on
"College Cost Projector" to get a good picture of what you will need
to save for you and/or your children.
can save for college expenses in a number of ways...
State Sponsored 529 Plan
A state-sponsored 529 plan allows your savings to grow tax free. You will pay no taxes if the withdrawals are used for "qualified" (tuition, fees, supplies, and room & board) college expenses.
You can set up a 529 plan regardless of your income and the contribution limit is much higher than that of a Coverdell Account. You may also get a tax deduction or tax break on your State income tax return in some states.
You can also use the funds for another child of yours--if the designated child decides not to attend college.
If you wthdraw the money and use it
for any purpose other than education you will be taxed at your ordinary income
rate plus a 10% penalty--on earnings--but not contributions. If you claimed a
State tax deduction or credit--that too would possibly have to be paid back.
State Pre-Paid Tuition Plan
If you are planning to send your kid to school in-state you should consider a state prepaid tuition plan which offers the same tax benefits of a 529 plan--but allows you to lock in tuition rates in your state years in advance.
Be careful when analyzing prepaid tuition as many states are facing difficulty in administering the plan.
In most plans you can transfer the value of the account or get a refund if your child goes to an out of State or Private school. The tax benefits and penalty is the same as that of a 529 plan.
A Coverdell account is similar to a 529 and has the same tax benefits (tax deferral--along with being taxed at ordinary income with a 10% penalty on earnings if you do not use the funds for qualified tuition--however, you can use the money for tuition at private elementary and high schools as well as for college.
With a Coverdell account you also have more control over your investment choices.
You can open a Coverdell Account at a Bank or Brokerage Office. The contribution limit cannot be higher than $2,000 a year and your beneficiary has to be under age 18.
There are also income limits
($110,000 single with Modified Adjusted Gross Income--$220,000 married filing
joint). Some provisions of the Coverdell Account are scheduled to expire in
2013 unless Congress decides to extend them.
Employer Provided Assistance
Some employer's offer assistance to teens in the form of scholarships and monetary assistance. Also, if you as an adult wanted to pursue higher education to enhance your position with your company--many employer's offer assistance.
Be sure to see if your or your
child's employer offer educational assistance.
Custodial accounts (Trusts) are yet another option when saving for college--you would put the money in your child's account and manage it (you would be the Trustee) until they turn 18 or 21, depending on your State. When the child turns 18 or 21 they would be able to do what they wish with the money.
Some of the contributions would be income tax free, some would be taxed at the child's rate and some would be taxed at the parent (your) marginal tax rate depending on the contribution amount and earnings.
Custodial Accounts are also known as UGMA or UTMA Accounts which are acronyms for the Uniform Gift to Minors Act and Uniform Transfers to Minors Act.
You have more freedom if you choose
this option as the funds can be used outside of college funding and you have
more control over your investment choices than that of a 529 plan. However,
your child does not have to go to College--he or she may blow the money on a
ROTH IRA Account
ROTH accounts could also work for you--and as an added bonus if your child has enough to go to college with--other means such as your current income, financial aid, scholarships etc.--you could avoid using the ROTH and continue building up the account for your retirement years.
Withdrawals of your "contributions" would be tax free. There would be no 10% early-withdrawal penalty on earnings if you use the money for educational expenses. If you were under age 59 1/2 and held the account for less than five years you would owe tax on the "earnings" at your ordinary income tax rate plus a 10% penalty for early withdrawal unless an exception was applicable.
If you plan on using a ROTH make sure you have a well thought out strategy.
Be sure you have your retirement goals in place and a strategy to get to the "number" you need--dollar wise--to live at your pre-retirement levels.
For example, if your "number" was $500,000 and you were age 65 you would be able to withdraw $20,000 per year for approximately 30 years assuming a modest rate of return. You would also factor in your Social Security and any other income.
If tapping into your ROTH for your child's educational expenses would prevent you from getting to your "number" you would have to increase the ROTH contrbutions or other Retirement Account contributions--or pursue another educational funding strategy.
If you plan on using a ROTH account for educational funding be sure to start well in advance. ROTH accounts have a $5,000 per year limit--$6,000 if you are over age 50. If you are married your spouse can also contribute $5,000 or $6,000 per year.
Keep in mind that in order to contribute to a ROTH you must have earned income (employer or self-employed) and there are income limits of $122,000 Modified Adjusted Gross Income for Single and $179,000 for Married Filing Jointly.
If you contribute $5,000 annually from the time your child is born you would have $90,000 in "contributions" alone. Assuming you had a modest annual return, your total acount value could be over $200,000 by the time your child attended college.
If your spouse also contributed the total "contributions" would be $180,000 and the account value could be over $400,000 by the time your child attended college.
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