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IRA advantage. To plug gaps in your college-savings strategy, you could turn to your retirement accounts. You can avoid the 10% penalty on early withdrawals from an IRA if you use the money for qualified educational expenses, although you will owe income tax. In the case of a Roth IRA, you can withdraw your contributions tax-free at any time. You can also withdraw earnings to pay college bills without paying a penalty, but you'll owe income tax unless you're older than 59½ and you've had the IRA for at least five years.
New rates on loans
Just a few years ago, interest rates on federally subsidized student and parent loans were falling faster than a hard rain. But those days are over. Students now pay a fixed rate of 6.8% on new Stafford loans, and parents pay a fixed 8.5% on PLUS loans. Rates on older Staffords and PLUS loans continue to be variable -- this year, 6.5% or 7.1% (depending on when you repay) on Staffords, and 7.9% on PLUS loans.
If your loans date to earlier years, you can still consolidate them and lock in the current rate. Consolidating also lets you extend the repayment period on the loan. Some lenders offer rebates or discounts in return for timely payments.
Thanks to another new law, you can now shop for consolidation deals among lenders, regardless of your loans' origin. In the past, if your loans came from a single source, you had to apply to that lender first.
Private loans. The new math doesn't mean you should first seek private loans when you're borrowing for college. Gary Carpenter, executive director of the National Institute of Certified College Planners, says Staffords are still a bargain compared with private loans, which have variable rates that are pegged to the prime rate, recently 8%. And you can defer repayment on Staffords until after graduation (and again if you attend graduate school). Under some circumstances, the loans may be forgiven.
Tap home equity? Similar to Stafford loans, PLUS loans constitute easy borrowing, and at 8.5%, the rate is competitive with most private loans. But homeowners have a tempting alternative: a home-equity line of credit. At 8.2%, the recent average rate, home-equity lines beat the PLUS rate by a hair, and interest on up to $100,000 is tax-deductible.
But home-equity rates have been creeping up as interest rates have risen. Moreover, borrowing against your home could deplete one of your biggest assets just as you need it most. "When the kids graduate, many families want to sell the house, but they have to pay off the home-equity line," says Carpenter. "That takes cash out of their pockets." He advises clients to consider PLUS loans first.
PLUS loans were a godsend for Patrick and Barbara Brodie. When their son, Eric, was a baby, they stashed a small windfall in a custodial account that grew to six figures. The account tanked just as Eric was about to attend Emory University. Rather than take a loss, they used PLUS loans and Staffords to cover his tuition. "For four years of Emory, every bill was financed by loans," says Patrick. Eric has now earned his degree and landed a job, and his investments have rebounded. He uses the investment income to pay down the loans (his and his parents').
As far as his father is concerned, plan B worked beautifully. "I was a teacher, so I didn't have a large income," says Patrick, who is now retired. "I looked into the college bills and found a way to pay them."
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