HELOC versus other options for parental loan

I’m anti-PLUS myself. The PLUS loan is extremely easy to get with a very minimal credit check which does NOT include rating the ability to repay. This makes it attractive to colleges who need a way for families to afford their schools, but dangerous for families. Especially when parents choose to defer payments until the child graduates, they don’t realize how deep the hole they’re digging is.

Ideally parents wouldn’t have loans to pay for their children’s college. However, people with strong credit ratings can find better options than PLUS when necessary.

Before you take out any loans, figure out how much you can pay out of pocket monthly. Most colleges offer monthly payment plans and the one’s I’ve seen (and use) are fee-simple rather than interest based. They aren’t loans so they don’t ding your credit, and you can adjust yearly how much you pay.

Doing this, rather than taking out loans, means I have less extra cash in my pocket at the end of the month right now, but I don’t mind giving up vacations and putting off big purchases for a few years.

Not everyone has the cash flow or can make the lifestyle changes necessary to make this feasible but at least consider the ‘pay as you go’ option before digging into home equity or chaining yourself to loan payments if you can avoid it. You could even do a combination of both loan and payment plan. At least that way you’re minimizing your loan exposure.

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I believe that the accounts being referenced are normal checking or savings accounts where the cash out received after a mortgage refinancing has been deposited. Obviously, these accounts are reported on FAFSA and will impact a FAFSA EFC (as well as Profile).

@kelsmom, please correct me if I’m wrong, but this is my understanding of how Parent Plus loans work:

  1. the interest rate on Parent Plus loan is fixed
  2. you can qualify easier than going through a bank
  3. you can return it within 120 days and get all fees and interest refunded
  4. they can be discharged if student dies or parent borrower dies or becomes permanently disabled

If you only need to borrow a small amount, you could look into borrowing against a life insurance policy, or put the payment on a credit card and pay that off when you get your AOTC on your tax return, if you qualify (that might work well for the spring semester payment).
You can also sign up for a payment plan at the college and might be able to divide the bill into 8-10 payments.

I would also not borrow up to the COA. Make sure you can cover the billed costs, and the student might be able to cover some personal expenses, books with a campus job or summer earnings.

Ok…so…here is my suggestion. Let’s use an easy example for math purposes. If you borrow $25,000 a year for 4 years…your total will be $100,000 plus interest.

If your payments don’t start until after college graduation, then in 4 years, you will be looking at about $1300-$1500 in loan payments per month…for ten years.

So starting this month…take $1300 and put it in a dedicated account…if you plan to use it for education…how about a 529? You will have $7000 or so IN the bank before your kid starts college this fall.

But more important…you can see how easy or not it will be for YOU to live with that amount not available to you.

You know, there’s always the option of choosing a less expensive school. You wouldn’t be the first parents to tour schools before understanding finances only to have your kid fall in love with one that ends up being unaffordable. Is your daughter still hoping to attend Wesleyan? I’m sure it has a great English dept., but I wouldn’t take out parent loans for it.

You made this statement last summer. Did your daughter apply to any schools that you can pay for without having to borrow? I’d exhaust my search for those before taking loans.

A HELOC is so much cheaper. We got one recently for 3.2% and no closing costs. I would also rather have secured debt than unsecured debt. Better for your credit rating. Don’t take a straight home equity loan. You’ll be paying interest on the entire amount up front. Plus, the money you set aside for years 2-4 will be an asset in the bank that will figure into FA if you have to submit a CSS every year, or if you have a younger child coming up.

You are really comparing two very different loans types.

The HELOC is a secured loan and the rates are lower. The closing costs might be higher. The risk of losing your home is there. There used to be a tax benefit, but I don’t think there will be much of a benefit under the knew law. It may depend on which state you are in.

The PLUS is unsecured. It is a much more flexible loan, payments can be deferred while your student is in college, there is a origination fee of 5%, you borrow the money as you need it (yearly). The qualification to get it are easy to meet. It can easily be refinanced or consolidated after graduation and there are payment plans available. It does cost more if you pay it as agreed, but if you pay early or don’t need to borrow in later years, it might be cheaper overall.

Honestly, I wouldn’t do either loan. I’d find a cheaper college.

The other risk with taking a loan from your 401k is if you lose your job the loan becomes due NOW. Plus all the other negatives like the money being subject to taxation twice…most people overlook that part, but you really shouldn’t.

You wouldn’t have to come up the money, it’s just declared a taxable distribution. There may be a penalty & of course it would be counted as part of your income for the year.

I don’t understand the double taxation comment. The money was not taxed originally. You pay taxes on it whenever you take it out (not borrow, but take out permanently).

Something to consider, and you can only guess, is what rate of return do you expect from your 401(k) and what appreciation do you expect on your home? If you borrow from a retirement plan, you are reducing your principal & therefore some potential earnings.

It’s all very inexact, you just have to make the choice that you feel most comfortable with. For those who say never borrow against your retirement plan, well really your house is part of your retirement plan.

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@alooknac: the loan repayments are made with after-tax income (that’s once) and, second, when you take those payments out as a distribution at retirement you pay income tax on them (that’s twice).

And yes you are right about losing your job you can just pay the penalty and the distributions are added to your income. It “could” throw you in a higher tax bracket and then you could owe the IRS.

Everyone needs to just be aware and do what’s right for you.

No matter what loan a person might take out, they are making their payments with after tax income.

Borrowing against a 401(k) does have the advantage that you are actually paying the interest to yourself, as mentioned earlier.

@swtaffy904 You mentioned you have a small 401K not from your current job. Most times you can roll it over to your current 401K. That might give you extra money to borrow from.

Scenario 1:
Earn money; pay income tax.
Use some of the earnings to pay down a car loan.

Scenario2:
Earn money; pay income tax.
Use some of the earnings to payback a 401(k) loan.
Years later in retirement, start taking out of the 401(k) the same dollars that paid the loan; pay income tax on those dollars a second time.

Right, but there’s no gain for the account owner here. Whether you pay interest to yourself while the loan is being paid back or there’s no interest on the loan, you have the same amount of money. And, depending on the account investment choice(s) and market performance, you could be giving up tax-deferred earnings on the outstanding balance of the loan principal.

The year before my oldest was set to go to college, which I had thought about funding through a 401 k like you were, I was downsized from my job of 22 years. Just saying that you can’t count on continued employment in this day and age. I am at my current job for 11 years and would not consider a 401 k loan for S17 based on my past experience.

HELOC interest is no longer deductible but if you refinance, there may be a mortgage recording fee and other taxes depending on your locality which could increase your costs.

My solution was to tell my kids that they had a budget of the cost of an instate school, which I could satisfy with savings and current income.