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How Much Should Parents Borrow For Their Kid's College?


Sending your kid off to college is a happy milestone for most parents, but figuring out how to pay for it can be overwhelming.

The average annual cost of tuition, fees, and room and board rose 3.1%—to $20,770—for a public university with in-state tuition and 3.5%—to $46,950—at a private college for the 2017-2018 school year, according to the College Board.

Over four years, that adds up to a total cost of $83,000 for a state school and $188,000 for a private university. And that doesn't even include books, supplies, transportation and other expenses, which can add thousands more to the total cost. 

Financial aid, including scholarships and loans, is rarely enough to pay those costs. That leaves parents, the second largest source of college funds, to fill the financial gap.

Some 42% of families borrow money to pay for college, according to Sallie Mae’s How America Pays for College 2017 survey of undergraduate students and their parents. 

But some parents are borrowing more than they can afford—and a growing number are taking on larger loan balances than their kids. That's because more students are hitting the borrowing ceiling for federal loans—recently $31,000 for undergrads—leaving parents to fill the gap. About 40.3% of students hit the loan ceiling in the 2015-2016 academic year, up from 39.3% four years earlier.

“College debt is increasingly becoming a parent problem, too,” says Mark Kantrowitz, publisher and vice president of research at SavingForCollege.com, which provides information on financial aid and 529 college savings plans.

In a recent analysis of federal college loan data, Kantrowitz found that the average amount parents borrowed in federal Parent PLUS loans totaled $33,596 in the 2015-2016 school year (the latest year data was available), up from $27,352 in 2011-2012. Meanwhile, students borrowed on average $29,669 in federal loans in 2015-2016, almost unchanged from 2011-2012.

That disparity is likely to grow as college costs continue to rise. Kantrowitz estimates that parental debt from federal college loans will average $37,180 for 2017-2018 while the average amount that grads borrow remains flat at $29,884.

Of course, most parents are willing to make financial sacrifices to cover their children's college costs. But these rising debt burdens mean that some families will be putting their finances at risk.

A 2017 report by the Consumer Financial Protection Bureau found that people over 60 years old are the fastest-growing group of student loan borrowers (mainly to pay college costs for their kids) and are more likely to default on loans than their younger counterparts.

If you're planning to borrow to pay your kid's college bills, it's crucial do it the right way to avoid jeopardizing your financial security. Here are five guidelines to follow.

Be Realistic About What You Can Afford
Given the steep costs of college, few families can put away enough to pay the full amount. Instead, Kantrowitz recommends a less daunting savings target: Aim to have enough savings to pay one-third of your kids’ college costs by the time they start school.

Another third can be covered by current income, plus scholarships and grants from college, state, and federal programs. The final third can be funded with loans taken out by the student and parents.

When your child reaches high school, start scoping out schools that are likely to be affordable. Every school has an online net price calculator that will give you an estimate of your family’s share of the cost to attend.

By comparing the expected cost with your savings and income, you and your child can focus on a list of schools that are likely to be within your financial reach. Just remember that you won't find out the actual costs until your child is admitted and receives a detailed financial aid package. 

Explore All Sources of Funding
Make sure to apply for financial aid even if you think you won't qualify for need-based assistance. Half of families report getting scholarships and grants to pay for school, mainly provided from the college itself. But you won’t be considered for most aid unless you fill out the Free Application for Federal Student Aid (FAFSA).

You can apply as early as October of the year before your child plans to enter college and submit the FAFSA anytime during the school year you are enrolled. If your child has work-study or a part-time job during the school year or a summer job, he or she could contribute several thousand dollars to costs. Students can earn up to $6,500 a year without hurting their financial aid eligibility.

Borrow Strategically
There’s nothing wrong with borrowing—just don’t take on more than you can afford, says Kantrowitz. Stick to federally backed loans, which have fixed interest rates and more flexible payment options compared with private loans.

Your child should max out federal loans before you take on debt. Student loans are less expensive than Parent PLUS or private loans, and you don’t need a co-signer. Undergraduate student loan rates are set at 5.05% for the 2018-2019 school year vs. 7.60% for Parent PLUS loans. You can always help out on payments.

If you do decide to borrow, here’s a good rule of thumb: Parents who use the standard 10-year repayment plan on federal loans shouldn’t borrow more than their annual income to cover all their children’s college costs.

And if retirement is less than 10 years away, you need to ratchet that down. If you’re just five years from the finish line, for example, don’t borrow more than half your annual income. 

Don’t Risk Your Retirement Assets
You might be tempted to take a loan from your 401(k), but it’s a costly move. Unlike the pretax money you use to fund the 401(k), you pay the loan back with after-tax money. You’re taxed again when you withdraw the money in retirement.

Then there's the cost of missing out on any growth on that borrowed money while you’re paying back the loan. And if you leave your job, you may have to repay the whole loan right away.

The IRS waives the 10 percent early-withdrawal penalty if you use IRA money for higher-education expenses. But you’ll still have to pay income taxes on the amount you withdraw, and that could bump you into a higher tax bracket. 

Be Careful About Tapping Home Equity
Taking a home equity loan may look attractive because you typically can get a much lower interest rate than with federal parent loans. Home equity lines of credit are averaging 5.79%, according to Bankrate.com vs. the 7.60% percent PLUS loan rate.

But there are a lot of reasons to be wary of this option. The money you get from a home equity loan is counted as income and could make it harder for your child to qualify for financial aid.

It’s also a less attractive move under the new tax law that took effect this year. You are no longer allowed to deduct the interest on a home equity loan if you use it to pay for college.

There are a number of risks, too. You’ll use up valuable equity that you might want in retirement if you planned to sell your home and downsize. If you carry your mortgage into retirement, that’ll hurt your post-work budget. And if you have trouble paying the loan, you could lose your home.  

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