How to Pay for Your Kid's College: What Parents Need to Know
A goal for a lot of parents is to pay for their kid's college. This can get expensive and confusing. This article breaks down and offers some options that may work for your family.
As a parent, you want to provide your child with the best opportunities in life. And for many parents, paying for college for their children is a part of doing that.
Unfortunately, covering the costs of tuition can be very expensive and it isn't always easy to figure out how to pay for kids' college tuition even if you want to. The good news is, parents have many different options for securing the funding they need to help their children earn a degree.
Here's what you need to know.
Are parents legally obligated to pay for tuition?
In general, there are no laws requiring parents to pay for college tuition for their children. As a result, paying for kids' college is optional and parents can choose whether to do it or not.
However, there may be a limited exception in divorce situations, if the divorce agreement imposed a requirement for one of the parents to pay for college. In this case, it would be a private contract between the two ex-spouses that mandates a parent paying for college.
Once parents agree to take on certain obligations, however, then they become legally responsible for them. For example, parents who take out student loans in their own name are legally liable to pay them back. And parents who cosign for their children's student loans are also legally responsible for paying them back along with their child.
Is a parent paying for college a good idea?
A parent paying for college can be a huge benefit for children.
When parents cover college costs, kids don't have to borrow and start their adult lives with a negative net worth. Because they don't incur interest costs, their education is also less expensive than if they had to borrow for it. And they can choose which college to attend based on their interests, rather than based on where they received the best financial aid package.
However, there are some big downsides to parents paying for college tuition. Doing so could compromise their own financial goals. Children also lose the opportunity to get student loans to help them build credit. And they may not be as motivated to succeed when it's not their own money on the line.
Ultimately, a lot comes down to the question of exactly how do parents pay for college. If they jeopardize their retirement or their home to cover the costs and then things go wrong, this could be a disaster for the family as a whole. Parents need to carefully consider their own finances before making their choice.
How do parents pay for college?
So how do parents pay for college if they decide to do so? There are a few key options including the following.
529 college savings plans allow parents to save money over time that can go towards paying for kids' college. Each state operates its own 529 plan and parents can become eligible for tax benefits by contributing to a 529 account. The money can be invested and grow over time.
Using a 529 plan can be a great option for a parent paying for college because you won't have to come up with a huge sum of money all at one time once the tuition bill comes due. You'll save up the funds by contributing a little bit each month or each year and will be able to withdraw the money for qualifying educational expenses.
Using a 529 can also limit the need to borrow. For parents paying for college tuition, not having to cover interest costs on a loan could provide huge savings.
Federal student loans
Parents of dependent undergraduates can take out federal PLUS Loans. These can provide funding for up to the school certified cost of attendance, minus other financial aid sources.
Parents need to complete a portion of the Free Application for Federal Student Aid (FAFSA) to become eligible for PLUS Loans. And they cannot have adverse credit in order to qualify for them.
PLUS Loans come with many of the same benefits and protections as other federal loans, including options for loan forgiveness and income-driven payment. However, the origination fee and interest rate can be higher than for federal Direct Loans.
Tapping your retirement accounts
Parents could choose to borrow against a 401(k) account to fund their child's schooling. However, there are loan limits and not all plans allow this. Parents would pay interest to themselves with this approach, but it could put their future financial security at risk if they lose out on investment gains or can't pay back the loan.
Withdrawing money from retirement accounts could also be an option, but is rarely a good one. Parents under 59 ½ would generally owe an early withdrawal penalty on at least part of the money they take out, and may also face income taxes on the money depending what type of retirement account they have.
Draining your retirement nest egg is generally considered to be a really dangerous option for parents paying for college tuition. While kids can borrow to go to school, parents cannot borrow their way through an underfunded retirement.
Using home equity
Finally, parents paying for college could access some of the equity in their homes by taking a cash out refinance; home equity loan; or home equity line of credit.
Each of these approaches would involve paying closing costs and also putting your home in jeopardy if you can't pay the bills. This is also a risky move, although the benefit is that the interest rate on home loans is usually relatively low. And in the event you took out a cash-out refinance loan, it's possible that interest could be tax-deductible if you itemize on your tax return.
Private student loans
Private loans can be a great alternative to federal loans, 401(k) loans, or home equity loans.
Private student loans are made by individual private lenders. There are many different lenders that offer them and they often have very favorable terms, including interest rates that may be below Parent PLUS Loans. Many private loan lenders also do not charge origination fees, unlike the Department of Education which does impose this up-front cost for PLUS loans.
While parents won't get all of the same borrower benefits with private loans as they do with federal ones, they can shop around for a loan with terms that fits their needs. Juno can make this process easy for parents. We get together groups of borrowers and negotiate on their behalf with lenders to get better rates as they compete for business.
Christy Rakoczy Bieber
Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher with experience writing textbooks and serving as a subject matter expert.
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