Financing College Means Saving Now or Borrowing Later

Financing a college education involves more than simply writing a check for the cost of tuition, room and board. For starters, that’s a pretty hefty check being written nowadays. How you obtain the funds to write that check requires research and careful planning, because there are options to consider.

“It’s a family preference,” says Aimee Bristow, director of financial aid for Fulton, Missouri-based Westminster College, which has a very reputable biology/pre-med undergrad program and a strong alumni tradition. “They’re either saving and planning in advance so they can pay as they go, or borrowing the money and paying afterwards. But because disposable income isn’t quite as readily available due to the economy, we’re seeing more of a trend towards borrowing right now.”

Starting early

If you’re in the former of the two above-mentioned categories, you may want to consider—if you’re not already—utilizing a 529 savings plan. The funds accumulated in a 529 plan are free from federal income tax if used for eligible college expenses. That, however, is an important catch.

If your son or daughter decides not to enter college but to attend a trade school and open a business, the money in the 529, if used to open the business, would be subject to tax and penalty. Even if your child does attend college, the money could also be subject to state income tax if a non-state plan is used.

Roth IRAs are another consideration, especially with recent rules changes that make the Roth a bit more appealing and available for physicians and other high-income earners. The Roth allows for tax-free withdrawals at any time on the earnings if the owner of the IRA is at least 59-1/2 years old and the IRA has been in place for at least five years. With the Roth, however, if the funds are not used for college, there’s no penalty for using the savings to supplement your own retirement.

It’s important to note that there are a wide range of 529 savings plans available, and a good place to start your research is at www.529.com, an informational website created by Sallie Mae affiliate Upromise Investments, the largest administrator of college savings plans in the country.

The loan option

If you’re going to borrow to finance the cost of a college education, Bristow suggests you start by maximizing Federal Stafford Loan eligibility first. The rationale is simple: the interest rate is the lowest of all loan programs—fixed at 6.8 percent. The drawback is that an incoming freshman is limited to borrowing $5,500 per year. That may not seem like much, given the rising cost of a college education, but Bristow points out that “it’s the cheapest way to borrow at least some of the money.”

So, where does the balance come from? “Once a student has borrowed the maximum a Federal Stafford Loan allows, the next program I recommend families consider would be the Federal PLUS Loan,” Bristow says. The PLUS loan is a credit-based loan available to parents of dependent students for the purpose of funding their child’s education. It has a fixed rate of 7.9 percent through the direct lending program, or 8.5 percent through the federal family educational loan program—depending on which program the college is participating. The benefit is the absence of a loan ceiling as with the Stafford loan. “If parents need $50,000 to pay for a Harvard education, and they want to finance all of it, they can do that through the Federal PLUS Loan program, as long as they are credit worthy.”

A last loan option is a private, alternative loan, allowing a student to borrow money with a credit-worthy cosigner. Bristow suggests that option as a last resort because “the interest rates are usually variable, and there is no cap. So, if we see really high interest rates over the life of that loan, the borrower will be subject to those higher rates.”

Apply for scholarships

There are essentially two types of scholarships that college-bound students and their families should be aware of: those funded by the educational institution, and those funded privately, often by local businesses or civic organizations. Where college-funded scholarships are concerned, be particularly aware of deadlines for filing. Missing a deadline can mean missing out on consideration for these merit- or participation-based scholarships.

Bristow adds that where privately funded scholarships are concerned, there are several free online scholarship searches that students can access to find information about these scholarship types both in and out of their area. “And I emphasize free,” she says, “because there are companies out there that will charge a fee to conduct research for scholarship opportunities.” Those fees can range from $500 up to several thousand dollars. “Students and their families can do that same research on their own and save themselves that upfront service fee.”