The Money Question: Should We Tap Our Home Equity to Help Our Daughter Pay for College?
Q. Our high school senior is deciding which college to attend. She'll have to take out loans and, frankly, we're surprised at the high interest rates. Should we tap our home equity instead?
If you have equity in your home, congratulations: The drop in real-estate value has eliminated this option for many families. Even so, I always caution clients to think carefully about borrowing against their home for college, especially if they have more than one child. Your daughter has many more years of earning ahead of her than you do. Taking on all that debt yourself could lower your own standard of living or, worse, jeopardize your retirement.
By the same token, student-loan debt can be a major burden to a young college graduate. That's a big reason I urge parents to keep affordability top of mind when they're helping a child choose a college. Every penny not spent is a penny you don't have to borrow.
Here's a brief rundown of the options.
Loans for Students
All school-based student loans are now government-backed. Some are administered by the schools and some come directly from the federal government. Thankfully, applicants submit just one form and hear back from each college about what type of assistance (including loans, grants, and work-study options) they qualify for.
Standard: The Stafford Unsubsidized loan carries a relatively high 6.8 percent interest rate over a 10- or 25-year term. Still, no payments are due until six months after graduation and those can be pushed back further if it takes your daughter a while to find a job. Interest, however, begins accruing immediately and gets rolled into the principal. Payments can be adjusted to increase over time (presumably along with income) and up to $2,500 in interest per year is tax deductible as long as your daughter earns less than $75,000.
Based on Need: Two other programs are available to families demonstrating financial need (to determine your need, go to studentaid.ed.gov). Perkins loans have 5 percent interest and Stafford Subsidized loans just 3.4 percent. Otherwise, they're similar to standard loans, except (a big plus) no interest accrues until nine months after your daughter graduates or leaves school. Any outstanding debt may be forgiven if she works full-time in government or at a nonprofit agency for at least 10 years.
The total amount your daughter can borrow can't exceed $5,500 the first year, $6,500 the second year, and $7,500 in the third and fourth. This, of course, leaves a considerable shortfall.
Private Student Loans: These loans help you cover that shortfall. Interest rates are generally variable, sometimes as low as 3 percent initially but climbing over time to 10 percent or higher. Banks usually follow the same parameters as standard student loans regarding terms and deferral of payments. Look at bank websites to find the best rates. Since this loan will be in your daughter's name, make sure that she understands the effect such a large debt may have on her financial independence down the road.
Loans for Parents
Students aren't the only ones who can take out student loans. The Federal Direct Plus loan program lends to parents of college students, at 7.9 percent, up to the full cost of college minus the student's own loans. As with student borrowers, up to $2,500 in interest per year is deductible, as long as household income is less than $150,000 for a married couple or $75,000 for single parents. These loans, of course, are in your name, so you're on the hook for repayment. If you expect your daughter to pay them back, I recommend writing a formal document detailing your arrangement.
Home Equity: If you do decide to take this route, how much can you borrow? The math is pretty simple: Take your home's current appraised value, multiply it by 80 percent, then subtract your current mortgage balance. Interest on a home equity loan is currently around 6 percent. You could get a rate of 3 to 5 percent by using a home equity line of credit (which you draw on as you need funds). But line of credit rates are variable and could someday skyrocket. To lock in today's low rates (currently about 3.9 percent for a 30-year loan), you'd need to refinance, essentially taking out a new mortgage to cover what you still owe on your house plus college costs. With any home borrowing, you have to begin repayment immediately, though the interest is tax deductible.
Eleanor Blayney, the author of Women's Worth: Finding Your Financial Confidence, is a certified financial planner and principal at Directions for Women, in McLean, Virginia. She's also a consumer advocate for the CFP Board of Standards, a certifying organization for financial planners.