Parents who need to borrow to help cover college expenses should consider the these options.
If federal student loans are not already part of your family college funding plan, then you should strongly consider requiring the student to borrow the maximum federal student loan each year before taking on parent debt. The Federal Student Loan programs offer interest rates and repayment options that are usually more reasonable than the parent loan options available to you. It’s also not a bad idea for the student to have some skin in the game. And it will help them build a credit history. You can always help your children repay these loans after graduation if you wish.
Federal Parent Loan for Undergraduate Students (PLUS)
Many parents borrow through the PLUS program due to the simple credit check and flexible loan limits that allow parents to borrow up to the full cost of attendance. There are some downsides, however, as these loans are relatively expensive and not dischargeable in the event of bankruptcy.
Families strong average credit scores and resources may find private education loans to be a less costly way to finance college costs. But private education loans offer fewer repayment options and borrower benefits that federal education loans.
The Tax Cuts and Jobs Act made the following changes to federal education loan discharges in tax years 2018 – 2025:
Federal Stafford Loans, Federal Perkins Loans and Federal Grad Plus Loans that are discharged due to the death or permanent disability of the student borrower are NOT considered income when cancelled.
Federal Parent Plus Loans discharged due to the death of the student for whom the funds were borrowed are no longer considered income to the parents when cancelled.
Loans from Family
Loans from family usually have a lower interest rate than other options and they don’t require credit checks or other complicated application processes. That said, if you have trouble repaying the loan, it could lead to bad feelings and possibly financial distress for the lender.
Cash Value Life Insurance Policy Loans
Whole life, variable life and universal life insurance policies all have a cash value component that you can borrow against. Interest rates vary. In most cases, as the owner of the policy, you determine when to repay the loan. The good news is that you pay the interest to yourself. The bad news is that if you don’t at least pay the interest on the loan each year, you could erode the cash value and might eventually put your policy at risk. Your insurance agent will confirm all terms and conditions and help you decide if this type of loan is a good idea.
Home Equity Loans
There are a few different options. Some parents refinance at a lower interest rate to reduce monthly mortgage payments and free cash flow for college expenses. Some parents opt for a “cash out” refinance which replaces the current mortgage with a bigger loan but results in a lump sum cash payout for the difference. Some parents borrow through a home equity line of credit – HELOC. Remember that your home serves as collateral for these loans.
The Tax Cuts and Jobs Act eliminated the deduction for interest paid on Home Equity Line of Credit Loans for tax years 2018-2025. Be sure to check with your tax advisor to determine if a HELOC is appropriate for your family.
401(k) Loans
Some 401k plans permit account owners to borrow up to 50% of the vested account balance. The interest rate is set by the plan and is usually tied to the prime rate. But these are short-term loans that must be repaid within five years through payroll deductions. If you are under the age of 59 & ½ and fail repay the loan, any unpaid balance is treated as a non-qualified withdrawal and, therefore, is subject to ordinary income tax rates plus a 10% tax penalty.
