How to pay for college

During a college search, the excitement about academic programs and career-launching degree options can suddenly dwindle when you start tallying up the tuition, fees, and other costs. But college doesn’t have to require mortgaging your family’s future or sending your child into decades of debt. There are many options for putting funds together. Knowing what’s available can help ease money worries and get that enthusiasm growing again.

When you’re exploring college loans and savings options, it helps to understand two things. 

First, in general, the earlier you start saving, the better off you and your child will be when college time arrives. That’s because your money will increase through a process known as compounding. This happens when the money you invest grows beyond your initial contributions, thanks to earned interest. Then, that interest generates additional interest as time goes on. Essentially, compounding ensures that your funds generate their own earnings.

Second, many experts advise maxing out your retirement accounts first. Then you can prioritize and contribute to other savings goals, such as helping your child pay for college. Also, if other loan options have been exhausted, you can consider borrowing from your retirement account. But be sure you know the details about tax ramifications before going with this route.

There are two types of college savings plans that confer significant tax advantages. The first is a 529 plan. It can be used for tuition, books, fees, lab materials, computers, and even room and board. As long as you’re using the money for those kind of expenses, withdrawals from a 529 account aren’t subject to federal taxes.

Another option is a Coverdell Education Savings Account (ESA), which has a lower annual maximum contribution rate than a 529, but offers more flexibility in directing your investments, as well as paying for some K through 12 expenses. You don’t have to choose between a 529 and an ESA; some people have both plans, depending on what seems like the best fit for them.

In some instances, you won’t have to provide part—or sometimes all—of the college expenses on your own. Your children may qualify for scholarships and grants. These can be funded by a college directly, via a nonprofit or other outside organization, or even made available through your employer.

Another option is federal student aid, which is determined by each college and university based on applicant need. If your child is applying to several colleges, you can compare financial aid packages directly. That can help to determine how much you’ll need to contribute.

The federal loan program PLUS allows you to borrow the amount your child requires for education expenses. One of the advantages is a choice of repayment plans. 

Keep in mind, though, that unlike traditional loans, you won’t get a lower interest rate if you have a great credit score. Every PLUS borrower gets the same interest rate. That means you may be able to get a lower rate elsewhere. What’s more, all Direct PLUS Loans have a loan fee. It’s a proportion of the loan amount and is taken from each loan disbursement.

Be sure to do some loan shopping on interest rates, terms, and repayment timeframes to compare your options.

Taking out a student loan is usually advised when you’ve explored other options first. But it can be a good way to fill in gaps that might exist between the amount you've saved and the sum of college expenses. Federal loans used specifically for education purposes typically have lower interest than conventional loans, and students often don’t need to start repayment until after graduation.

If you’re a homeowner, you may have the opportunity to tap into home equity for quick funds that can be used for college expenses. The advantages are that home equity loans, such as lines of credit, are often lower in interest than other loan choices. Also, they’re often quickly obtained and immediately available.

But there are drawbacks as well, the biggest being that you risk loss of your house if there are any problems with repayment. Before using this option, talk with a financial advisor to see whether it's viable for your situation.

Another way to reduce your contribution amount is to get help from friends and family. There’s a process called “qualified transfers” that lets contributors pay as much as they want toward tuition, as long as the funds go to a qualified institution. The benefit here is that they won’t have to pay gift tax.

With this option, and any of the others, it’s advisable to consult a tax specialist or financial advisor, to make sure you’re making the most of your contributions.