This is the third of a three-part series on saving for college. The blog posts have focused on strategies and advice for parents of newborns, elementary schoolers, and, now, middle and high school age kids. In other words, no matter how old your child is, it’s never too late or too early to start saving for college!
It’s amazing how quickly the years fly by, isn’t it? The old adage that raising children makes for long days and short years has played out, and you have something less than seven years before your child heads off to college. It’s time to get serious.
If you haven’t started saving yet, your plan may be for your student to borrow to pay for their education. This is not a realistic plan. The federal government limits how much a dependent undergraduate can borrow in their own name to get a bachelor’s degree. The limit is $5,500-$7,500 per year, with a cumulative total of $31,000. If your child needs to borrow more, you will have to borrow on their behalf, or co-sign a private educational loan, since private lenders are unwilling to lend to 18-year-olds with little income and no established credit. In other words, in one way or another, you will be on the hook for most of the financing of your child’s education.
Once you know this, it makes sense to save as much as you can before your child goes to college. You can certainly explore using tax-advantaged savings vehicles like 529 College Savings Plans. However, the tax advantage for those plans is that earnings on the account are tax-free if used for college expenses. Since you don’t have as much time for your money to grow, your potential tax savings are not as significant, so it is less important for you to find the “right” savings vehicle and more important for you to just start saving.
Families with less time to save should also be careful about investing in prepaid tuition plans. Only eleven states have prepaid plans available for residents of their states, and the Private College 529 Plan is available for a group of about 300 private colleges. These programs allow you to purchase a portion of tuition (and sometimes room and board) at today’s prices plus a premium. If you are considering enrolling in your state’s plan or the private college plan, read the fine print carefully. Many have a minimum required number of years you invest. Also make sure you understand whether you will have enough time to earn back the premium and any interest you might be charged on a monthly installment plan. Generally speaking, prepaid plans work best for families who purchase credits many years ahead of time.
I have already written about the importance of a family budget—it matters even more at this stage, and your goals should be to pay off debt, save what you can, and improve cash flow so that when it comes time to pay for college, you’ll be ready to pay some expenses out of pocket and minimize what you need to finance.
If you need an incentive to save, it’s easy enough to estimate what the cost of financing will be. There are several student loan repayment calculators available – my two favorites are on bankrate.com and on the New York Times website.
A safe assumption is to use the cost of the Federal Direct PLUS Loan, a popular parent loan program available from the federal government. It has a fixed interest rate of 6.31% for loans borrowed in the2016-17 school year (the government sets the rate every July 1st—in recent years, rates have been 6.84% and 7.21%). The program also charges an up-front processing fee of 4.276%, and the standard length of repayment is 10 years, although if you borrow more than $30,000 you’ll have an extended repayment option available.
We’ve done the math, and calculated that a family that needs to finance $20K per year for four years of college can save almost $12K of interest and fees by saving $500 per month starting when their student is a 9th grader. Once you run your own numbers, I think you’ll agree—if you set aside your future monthly loan payment during the middle and high school years, it will reduce the amount you have to borrow and the fees and interest you will pay. College is expensive enough already, why make it more so? Good luck and happy saving!