College acceptance letters are in. Here's hoping that your young scholar got in to his or her first college choice, or failing that, a safety school. Now to cobble together a plan to fund that Expected Family Contribution, a measure of your family’s financial strength used to calculate financial aid.
Section 529 distributions
If you invested in a prepaid tuition plan, you're probably feeling pretty smart yourself. It's fraternal twin, the college savings plan, allows you to take distributions to pay for qualified education expenses. It's important to match the distribution year with the year in which you pay the expenses and not cross calendar years.
Federal Direct Loans
Virtually every student who files a FAFSA qualifies for a Federal Direct Loan. The loan is in the student's name, doesn't require a co-signer and has attractive options that a private student loan won't have, including income limitations on the loan-payment size and mandatory forgiveness after a period of years. The income limitations and mandatory forgiveness provisions are likely to be changed in the future as the government realizes how costly it is to provide these options, so regardless of whether the parents or the child plans to make the loan payments, the first place to shop for student loans is with this loan program.
Interest rates are going up on July 1, 2014. My guesstimate is for the new rates to go up by about 0.9 percent to 1 percent.
Federal student loans
|Loan type||July 1, 2013-June 30, 2014 interest rate|
|Direct subsidized loans (undergraduates)||3.86%|
|Direct unsubsidized loans (undergraduates)||3.86%|
|Direct unsubsidized loans (graduate or professional students)||5.41%|
|Direct PLUS loans (parents and graduate or professional students)||6.41%|
Source: U.S. Department of Education
PLUS loans are federal loans that graduate or professional degree students and parents of dependent undergraduate students can use to help pay for education expenses. The U.S. Department of Education makes Direct PLUS Loans to eligible borrowers through schools participating in the direct loan program. Borrowers have to have an sound credit history, or a co-signer will be required, and it can't be the student.
Qualified education expenses allow you to take money out of your individual retirement account penalty free, but you'll still owe income taxes, and the distribution will count against next year's aid package when you file next year's Free Application for Federal Student Aid. Waiting until Junior's senior year to tap that source is best from a financial-aid perspective. Roth IRA qualified distributions to fund qualified education expenses don't have the income tax considerations of a traditional IRA and also will avoid the 10 percent penalty tax. Like IRA distributions, it's important that the expense is paid the same year as the distribution.
Not my favorite way for parents to pay for school, but it may present a lower cost option than a PLUS loan for parents and doesn't involve a credit check. The downside is that the loan comes due when you separate from service with your employer. If you don't have the money to repay it, it is classified as a distribution and subject to income taxes and potentially subject to the penalty tax.
Home equity lines/loans/cash-out refinancings
Tapping the equity in your home to pay for college costs can be a low-cost source of funds. The interest expense is typically tax deductible, but the student-loan interest expense also may generate a tax deduction. There are financial aid implications, since FAFSA doesn't consider the value of your home in the aid equation, but money in the bank sure counts towards aid calculations. A home equity line of credit can resolve this issue because the money isn't sitting in the bank.
If your child is going to a private school, that school is likely to require the College Scholarship Service (CSS) Profile, and the CSS Profile does consider the parents' equity in their home. Read the Bankrate feature, CSS Profile: How to maximize financial aid, for more on that topic.
How are you paying for your child's college costs this fall? Are you tapping more than one of these?
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