HELOCs still a good choice for college bills
Borrowing against your home is still a good way to pay some of your kid's college bills.
It's not the best way -- federally guaranteed student loans are better -- but it's not the worst option, either. Private student loans are at the bottom of our list.
"There are lots of funding options. All of them are good for some families, but not every one is good for all families," says Dan Wansten, author of Cash for College. "Home equity loans are a solid option for many."
Start by filling out the Free Application for Federal Student Aid. You can get this from your child's college or high school, or on the student aid website. That's the form the U.S. Department of Education uses to determine how much you can afford to pay for college and what most colleges use to determine your child's financial aid package.
Most aid packages include a mixture of grants, scholarships, loans and work-study options. Many colleges require a student to formally accept a financial aid offer by signing the award and sending it back; others don't. If yours does, don't forget this important step.
You'll need to plan for the gap left between the financial aid package and what college will actually cost. If you've saved some money, expect to use one-quarter of that each of the four years your son or daughter is in college.
You'll need to borrow the rest. There are three options:
- Your home equity line of credit -- assuming you have enough equity built up to borrow.
- A Direct PLUS Loan sponsored by the federal government but available through banks and credit unions.
- A private student loan.
Here are four reasons to consider a HELOC as an option:
Reason 1. HELOCs charge lower interest rates. Rates on average have been much lower than what you'll pay for PLUS Loans or private student loans.
Fair warning: HELOC interest rates can fluctuate, where the PLUS Loan rate is locked at 7.9%.
"The concern with utilizing a HELOC is the very high probability of interest rates rising sometime beginning next year or so," says Bradley H. Bofford, managing partner of Financial Principles LLC in Fairfield, N.J. "The HELOC payments can end up ballooning far greater than anticipated."
Rates on private student loans are adjustable and based on your credit score. But even parents with excellent credit who cosign on the loan can expect to pay 8% to 8.5% APR.
Reason 2. The fees are usually lower, too. Most home equity lines of credit have no annual fees or application fees, though you may have to pay for an appraisal. HELOCs with annual fees usually cost no more than $80 a year.
For PLUS loans, a fee of up to 4% is deducted every time a portion of the loan is disbursed to your son or daughter's college.
With private student loans, most lenders charge a fixed percentage of the loan amount as a fee, which can range anywhere from zero for borrowers with the highest credit scores to 11% for those with marginal credit scores.
Reason 3. HELOCs are more flexible to repay. They only require you to pay the monthly interest on your outstanding balance. You can repay as much or as little of the balance as you like for up to 10 years.
Repayment on PLUS and private student loans is not required while the student is attending school at least half-time, but interest accrues from the minute the loan is taken out. You must start making regular interest and principal payments after your child graduates.
Watch out: Some private student loans will entice you with a lower rate while your child is in college but bump up the interest rate after graduation.
Reason 4. Most parents can deduct the interest on their HELOCs from their income taxes. The major exception is for taxpayers subject to the Alternative Minimum Tax, which only allows them to write off the interest on loans used to buy or improve a home.
While the interest on PLUS and private student loans is also deductible, that benefit is subject to more stringent income limits. Parents can only deduct some of the interest if their joint, adjusted gross income exceeds $120,000, and the deduction disappears for families that make more than $150,000.