Help! We Don’t Have Enough Savings to Pay for College

If don't have enough in the bank to pay for junior's college education, you have options. Here's how to assess them.

Q. What’s the best way to pay for college? We won’t get much financial aid and I think it will cost about $30,000 a year. We only have $40,000 saved. We have equity in our home, 401K plans, Roths and our son can take student loans. Help!
— Mom

A. There is no one best way to pay for college, but we want to give you some options to consider.

Like a lot of people, you might be surprised by how much of the bill won’t be covered by aid.

The first option to look at is scholarships, said Lisa McKnight, a certified financial planner with Lassus Wherley in New Providence, New Jersey.

Free money is the best money, she said.

“Consider schools where you child stands out academically for your best bet at scholarship offers,” she said. “You should also consider the many scholarships found within your local community.”

McKnight said high schools typically have resources for students to help them find scholarships. One other resource is The College Board, which has an extensive database of scholarships.

Next, your student should investigate work/study programs or working during school, McKnight said.

“Student employment via a federal work/study program, or even part-time work outside of a work/ study, is a great way to have the student help finance their education,” McKnight said. “It’s important to balance working with academics, so you will need to determine if you’re student is someone who can make both work.”

You won’t necessarily have to make a whopper payment for tuition. While universities will bill for each semester, it seems that coming up with a full semester’s payment all at once would be tough.

But, most schools offer payment plans that allow you to stretch payments out over the course of 10 months or a year, McKnight said.

Next, you’ll probably need to consider loans.

“Even parents who could afford to pay for college out-of-pocket may choose to make student loans part of their college payment strategy in order to avoid asset liquidation or to give their child some responsibility for his or her own education,” McKnight said.

You’ll need to see what federal loans you and your child are eligible for. Be sure to look at Direct Subsidized and Unsubsidized Loans and Direct Parent Plus Loans. You can find private loans too, but these often require a co-signer.

In looking at home equity, there are pros and cons here.

“It may be cheaper and easier to secure then a federal loan, it has fewer restrictions, and is tax-deductible,” McKnight said. “However, there are some significant cons — primarily home equity loan debt is secured by your home, giving the lender a legal claim to your home in the event of default.”

This becomes a secured debt backed by your home, McKnight said, and you’re basically putting your home on the line and you are trading a hard asset (your home) for a soft asset (education).

You said you have Roth IRAs, and you can withdraw from your Roth IRA contributions at any time without penalty or tax for any reason, McKnight said. You can also withdraw earnings without the 10% penalty if they’ll be used to pay for qualified education expenses.

Your 401K should be your absolute last resort.

The drawbacks are many.

If you withdraw funds before you are 59 1/2 years old, you may owe a 10% premature distribution penalty and taxes on the withdrawal, she said.

Plus, frequent dips into your 401K will reduce balances and the benefits of compounding and tax deferral, and ultimately the overall funds for your retirement, McKnight said.

“If you have no other options then the tap the 401K, consider a loan — if your plan allows — and read the fine print regarding interest, borrowing limits, repayment terms, etc.” she said. “Borrowing from your 401K will incur double taxation.”

By that she means you’re repaying the loan with after-tax money and then you will be taxed again when you withdraw the funds in retirement.

“If you quit or lose your job the loan balance may need to be repaid in full within 60 days,” she said. “It is very important to ensure that you aren’t putting yourself at risk in your effort to assist your children with paying for school.”

McKnight said because borrowing or withdrawing from retirement plans have risks, you should speak to a financial professional for help so you make an informed decision based on your overall situation, and help ensure that you aren’t putting yourself at risk in your effort to assist your child with paying for school.

“It is important that you explore all of your resources when developing a college payment plan,” she said. “A little strategic thinking can go a long way toward maximizing financial resources and minimizing college payment stress, no matter what your income level.”

[Editor’s Note: The interest rates on certain loans, like private student loans or home equity lines of credit, will be affected by your credit. You can see where yours stand by viewing your free credit report summary on Credit.com.]

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Should I Use Home Equity to Pay My Kid’s College Tuition?

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Q. What are the pros and cons of a home equity loan instead of a home equity line of credit? I’m thinking of using it for college tuition.
— Parent

A. Deciding the best place to take money to pay for college tuition is a hard decision that can stick with you for years after the student graduates.

You’re talking about taking funds from the value of your home to pay the tuition bills.

There are differences between a home equity loan and a home equity line of credit, or HELOC.

With a HELOC, the amount of the loan is basically your credit line and you draw on the credit line only when you need the money, said Sheri Iannetta Cupo, a certified financial planner with SageBroadview Financial Planning in Morristown, New Jersey.

The rate on a HELOC is variable.

“It is usually based on the prime rate plus or minus a factor, therefore there is the risk that the rate will rise while you are paying back the loan thereby increasing your expected monthly payment,” Cupo said.

Your monthly payments for a HELOC cover interest only during the draw period.

“This provides flexibility, but we recommend you pay more than the monthly required payment so you don’t dig yourself into a hole,” she said.

A home equity loan, in comparison, comes with a fixed rate and you get the funds in a lump sum. You’d also be in a regular payment plan the repay the money.

“A home equity loan could jeopardize need-based financial aid as the money received from the home equity loan that is not yet used to pay for college will negatively impact the FAFSA,” she said.

With either kind of borrowing, your home is collateral for these loans. If you cannot pay your loan then you could lose your house, Cupo said.

And if the value of your home falls, she said, you could end up owing more than your home is worth.

“Interest is generally deductible when these loans are used for college unless you are subject to Alternative Minimum Tax (AMT). Then home equity interest is only deductible when used to improve your home,” she said. “Home equity indebtedness — as opposed to a mortgage used only to buy or build a home — is only deductible on amounts up to $100,000.”

So which is best for you? That depends on your situation. Consider meeting with a financial adviser who can go over your entire financial picture to help you make the most informed decision for your family.

[Editor’s Note: Remember, missing payments on a home equity loan or HELOC can hurt your credit. You can see how your credit currently fares by viewing two of your credit scores for free each month on Credit.com.]

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12 Questions Every Contractor Should Be Able to Answer

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Should I Use the Value of My House as My Emergency Fund?

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Q. I don’t have an emergency fund, but I have always felt very secure knowing I have a zero balance, low-interest home equity line of credit that would allow me to get, on an emergency basis, close to three times my annual salary. Is this a legitimate substitute for a separate emergency fund? — Curious

A. A home equity line of credit is one kind of backup plan, but it’s not a foolproof kind of backup plan.

traditional emergency fund covers anywhere from 3 months to a year’s worth of expenses, depending on your personal needs. The money is usually kept in a safe and liquid account.

Chip Wieczorek, a certified financial planner with Tradition Capital Management in Summit, N.J., said it’s not advisable or realistic to keep two or three years of living expenses in a savings account with a near 0% yield.

However, he said, home equity lines have pitfalls.

“I advise clients to maintain three to six months of living expenses in a savings account in addition to establishing a home equity line of credit (HELOC) for large unexpected expenses,” he said.

Wieczorek said when using a line of credit as an emergency fund, you must be aware that lines have a draw period and a principal pay down period.

A typical HELOC has a seven- to 10-year draw period during which the client can access funds and make interest only payments based on a 20- to 30-year amortization schedule. After the draw period expires, funds can no longer be drawn from the line of credit and both principal and interest payments are required.

“You may think you have two to three years of salary accessible from your line of credit but if the draw period expires, your emergency fund has dried up, Wieczorek said. “Most people do not realize this and should review their HELOC terms on an annual basis.”

Also keep in mind that home equity lines are variable and can be frozen by a bank. The interest rate for the line is generally based on an index, such as the prime rate, Wieczorek said.

“This means that the interest rate can increase over time, which would increase your monthly payment as well,” he said.

Also, in 2008, major home equity lenders began informing borrowers that their home equity lines of credit had been frozen or restricted.

“Falling housing prices led to reduced equity for borrowers, which was perceived as an increased risk of foreclosure in the eyes of lenders,” he said. “Courts have held that a bank may freeze a HELOC in instances where a home’s value decreases substantially.”

Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Boonton, also referenced 2008 as a problem for many home equity line borrowers.

“It is very possible that the condition that requires you to tap into that credit line — you lost your job or got hurt — may make the bank close the credit line,” he said.

Lynch said a mortgage and a home equity line is not a loan on a home, but instead is a loan on your income.

“If that can be shut down, and that was your plan, you need a better plan,” he said. “Plan A never works. What’s your plan B and C?”

Consider going a more traditional route over time and build the kind of emergency fund you can always count on.

[Editor’s Note: If you plan on opening a home equity line of credit, make sure your credit score is in good shape, as it will be a major factor in determining the interest rate you’ll pay. You can check your credit scores for free on Credit.com.]

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Homeowners Have Something to Be Happy About Again — Their Home Values Are Rising

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American mortgage holders are optimistic that equity in their homes is rising, and that’s helping fuel— for better or worse — a huge increase in home equity lending.

Nearly half (46%) of all U.S. homeowners with a mortgage expect their equity will increase in 2016, with a quarter of these optimists expecting it to rise between 6% and 10%, according to a new survey released by nonbank lender loanDepot.com. The same survey found that many owners don’t realize how much the market has already recovered, loanDepot said. Only 57% think their home’s value rose at all during the past three years, and a quarter of that group thinks it rose less than 5%. The Case Shiller 20-city index shows prices rose twice that much, in fact, 10% from November 2013 to November 2015— though home price increases are intensely local, and not everyone in America is enjoying double-digit increases.

Still, more home equity seems to be translating into sharp rises in home equity lending activity. The number of new HELOCs — home equity lines of credit — originated from January to October 2015 was up 11.8% over the same period one year ago, and at the highest level since 2008, according to Equifax.

Meanwhile, the total balance of home equity loans originated from January to October 2015 was $21.9 billion, a 20.1% increase from same time a year ago; and the total number of new home equity loans for subprime borrowers (i.e. those with bad credit scores) was 652,200, an increase of 24.7% and the highest level since 2008.

The findings are consistent with a Credit.com report earlier this month revealing that the number of underwater homeowners — those who owe more on their mortgage than their home is worth — has dropped sharply.

Not surprisingly, there is a split in optimism between those who suffered the downdraft of the 2008-09 housing recession, and those who bought their homes later, loanDepot said.

  • More buyers who purchased after 2009 (64%) believe their home has gained value since 2013 compared to 58% of pre-2009 owners.
  • More buyers who purchased after 2009 (50%) expect to gain more equity this year compared to 43% of pre-2009 buyers.
  • More pre-2009 owners (65%) believe they have adequate equity now to take out a home equity loan compared to just over half (52%) of post-2009 buyers.

“Homeowners who bought during the housing boom are regaining equity many thought was lost forever, yet too many are not aware of the equity they have gained or they are unclear about how to determine changes in their equity,” said Bryan Sullivan, chief financial officer of loanDepot, LLC.

Plenty of online tools offer home value estimates, and owners who have been timid to look in recent years might take a glance at such sites — but keep in mind they offer only rough estimates. The true value of a home is only determined when a real buyer shows up ready to write a check.

But banks and other nonbank lenders believe the equity gain story enough to free up funds for home equity loans.

How to Use a Home Equity Loan

Homeowners often opt for a HELOC to finance overdue home improvements. The Harvard Joint Center for Housing Studies believes a boom in home improvement projects is coming. It projects spending growth for home improvements will accelerate from 4.3% in the first quarter of 2016 to 7.6% in the third quarter. (You can learn more about home equity loans and HELOCS here.)

Another common use for a home equity loan is to pay off credit card debt. But you should be careful of this tactic. Transitioning high-interest credit card debt into low-interest home equity debt can be tempting, and it can help some consumers get out of a big financial hole. But it often fails to solve the underlying problem of too much spending and not enough income. A return to equity shouldn’t mean a return to the kind of home-as-ATM free-spending habits some consumers adopted last decade.

 

If your credit score is good, a financial institution may even allow you to borrow up to 80% — or even 90% (but at a higher interest rate) of your home’s value. You can check two of your credit scores for free each month on Credit.com.

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