Too rich to get college aid for your kid, but too poor to pay out of pocket? Here's what to do.
If you’re set on covering your child’s tuition, you have two options: Get a student loan for parents or tap your home’s equity, if you have any. Here's how to decide which option is best.
—All parents want to pay for their kids’ college, but many families find themselves too wealthy to qualify for financial aid, yet too strapped to pay out of pocket.
If that’s the case for you, financial advisors agree you should prioritize retirement savings over paying for college. After all, your kid can take out federal student loans, but your nest egg won’t grow itself.
Still, if you’re set on covering your child’s tuition, you have two options: Get a student loan for parents or tap your home’s equity, if you have any.
Which is best? There’s no easy answer when your kids’ education, your own financial future and your home are at stake. Think through the factors below to help you decide what to do.
Take out a federal student loan for parents
You can borrow money for your kid’s college with a federal direct PLUS loan. To apply, submit the Free Application for Federal Student Aid, or FAFSA. The form will also make your child eligible for grants, scholarships, work study and federal student loans.
|PROS OF PLUS LOANS||CONS OF PLUS LOANS|
|Option to defer payments while the student is in school.||6.31% fixed interest rate.|
|Flexible repayment plans.||4.28% loan fee.|
|Loans are discharged upon death of the parent or child.||$2,500 annual tax deduction limit for student loans.|
Private lenders also offer parent loans. Going the private route may be best if you have excellent credit. A high credit score may qualify you for a lower interest rate than you’d get with a federal parent loan.
However, private loans don’t offer all of the benefits that federal loans do. Families should turn to private loans only if they’re in a strong financial position and have a large emergency fund, says Betsy Mayotte, director of consumer outreach and compliance at American Student Assistance, a Boston-based nonprofit.
Consider tapping your home equity
With home values high and mortgage rates low, it’s a great time to use your home equity, says Kevin McKinley, a financial planner and principal/owner of McKinley Money LLC in Eau Claire, Wisconsin.
There are three ways to unlock your equity:
- A home equity line of credit, or HELOC.
- A home equity loan, often referred to as a “second mortgage.”
- A cash-out mortgage refinance.
Depending on how you tap your equity, there are pros and cons to consider. For instance, you’ll have to pay closing costs if you refinance your mortgage.
|PROS OF TAPPING HOME EQUITY||CONS OF TAPPING HOME EQUITY|
|Low interest rates.||Increased risk of foreclosure if home values drop or you can’t make payments.|
|Get a tax deduction for all the interest you pay, in most cases.||Could count against future financial aid eligibility.|
Tapping your home equity is risky because you’re putting one of your most valuable assets on the line. If you can’t make the payments or your home’s value declines, you could lose it.
“You don’t want to take out equity to the point where if the housing market drops, all of the sudden you’re underwater,” Mayotte says.
Despite the risks, tapping your equity may be a better deal than a student loan “when it comes to just straight dollars and cents,” McKinley says. But he also acknowledges an emotional component involved with using home equity.
“Some people are uncomfortable with the notion of mortgaging their home,” he says. “If that’s the case, they should just get student loans.”
This decision is weighty enough that it’s worth consulting a financial advisor. Feeling confident about the way your family pays for tuition will help you keep calm as you face one of the biggest transitions as a parent: sending your kid off to college.
Teddy Nykiel is a staff writer at NerdWallet, a personal finance website. Email: firstname.lastname@example.org. Twitter: @teddynykiel.
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