Our child is heading to college. Even with grants and student loans, we come up short. Any advice? —S.V., via e-mail
See Our Slide Show: 7 Smart Ways to Pay for College
First, contact the college financial aid office and ask it to review the financial aid award. Be sure to alert the financial aid officer about any recent changes in your financial situation—say, high medical bills or a job loss—that might justify bumping up your award, preferably with grants. While you're casting about for extra money, don't forget to figure in your student's upcoming summer earnings. After all, paying for college is a family endeavor.
1. Tap home equity. One alternative is to take out a home-equity line of credit or home-equity loan. Equity lines carry a variable interest rate, recently averaging about 4.5%; the rate on home-equity loans is fixed, lately at about 5.4%. With the equity line, you borrow the money as you need it, which can be less expensive than an equity loan, in which you borrow the entire amount—and pay interest on it—upfront. Either way, you can deduct the interest on home-equity debt up to $100,000. Keep in mind that borrowing against home equity puts your home at risk if you can’t pay off the loan. And if home values drop, you could end up owing more than your home is worth.
2. Take out a parent PLUS loan. These federally sponsored loans, set at a fixed 7.9%, may seem costly compared with the current low rates on other loans, but they are worth looking at for their flexibility. For starters, they are relatively easy to get, requiring only that you have no adverse credit history, such as a recent bankruptcy. You can borrow up to the cost of attendance and defer repayment while your student is in college. When you do repay, you have your choice of several repayment schedules. You can also qualify for discharge of the loan under some circumstances. To apply for a PLUS, you should fill out the Free Application for Federal Student Aid (FAFSA).
3. Draw on your Roth IRA. In an ideal world, your retirement funds would be sacred. (College is optional. Old age is not.) But if you must tap a retirement account, choose the Roth. With these accounts, you can withdraw your contributions for any reason, including college, without owing tax on the distribution. You do pay tax on earnings (unless you're 59½ or older and have had an account for at least five calendar years), but you sidestep the 10% early-withdrawal penalty if you use the money for higher-education expenses. Traditional IRAs also let you avoid the early-withdrawal penalty on the payout taken before age 59½ if you use the money for qualified higher-education expenses, but you have to pay income tax on the entire distribution, freeing up less for college and delivering a permanent hit to your retirement fund.
4. Borrow from your 401(k). If your company permits, you can borrow up to half of your account balance, up to a maximum of $50,000, and you have five years in which to repay the amount plus interest. The upside of this approach is that you repay yourself, as opposed to a bank or the federal government. The downside: If you lose your job, you'll generally have only 60 to 90 days to repay the loan.
5. Just say no. You could decide the school is too expensive for your budget and ask your student to choose a cheaper one. There's no shame in going with a more affordable option, especially if it means your child collects a degree without either of you loading up on debt.