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How Much Should Parents Borrow for Their Kid's College?

Donna Rosato

Consumer Reports has no financial relationship with advertisers on this site.

Consumer Reports has no financial relationship with advertisers on this site.

Sending your kid off to college is a happy milestone for most parents, but figuring out how to pay for it can be overwhelming.

The average annual cost of tuition, fees, and room and board for the 2018-2019 school year rose 2.8 percent from a year earlier—to $21,370—for a public university with in-state tuition, and 3.2 percent—to $48,510—at a private college, according to the College Board.

Over four years, tuition at a state school adds up to $85,000; at a private university, it's $195,000. And that doesn't even include books and supplies, transportation, and other expenses, which can add thousands more to the total. 

Financial aid, including scholarships and loans, is rarely enough to cover all of those costs. But students are limited in how much they can borrow in total in federal loans to pay for school, currently capped at $31,000 for undergrads. That leaves parents, the second largest source of college funds, to fill the financial gap.

About half of families say they borrow money to pay for college, and among those who borrow, one-quarter report that only parents are taking out loans, according to Sallie Mae’s How America Pays for College 2018 survey of undergraduate students and their parents. 

As the cost of college rises, it's not surprising that the amount that parents borrow is growing fast. Unlike students, parents can borrow almost unlimited amounts from the federal government through the Parent PLUS program and need to pass only minimal credit checks.

A report from the Urban Institute and New America out last month found that federal Parent PLUS loans accounted for 23 percent of total federal lending for undergraduates in the 2017-2018 academic year, up from 14 percent in 2012-13. 

On average, parents who take out loans borrow $16,000 a year, up from $11,000 a decade ago, according to a recent report by the Brookings Institute. They can take out loans for multiple years and multiple children, so total balances are growing. Nearly 10 percent owe more than $100,000 in parent loans. Parent PLUS loans also have higher rates and fees, and they don't come with as many protections as student federal loans.

“College debt is increasingly becoming a parent problem, too,” says Mark Kantrowitz, publisher and vice president of research at SavingForCollege.com, which provides information on financial aid and 529 college savings plans.

Of course, most parents are willing to make financial sacrifices to cover their children's college costs. But the rising cost of college means that some families are putting their own finances at risk to help their kids pay for school. 

One-third of parents surveyed in the Urban Institute New America report said they would be solely responsible for repaying borrowed money, and half said they would share the responsibility for making payments with the student. And the Brookings Institute report found that parent default rates are rising.

If you're planning to borrow to pay your kid's college bills, it's crucial to do it the right way to avoid jeopardizing your financial security. Here are five guidelines to follow.

Be Realistic About What You Can Afford

Given the steep costs of college, few families can put away enough to pay the full amount. Instead, Kantrowitz recommends a less daunting savings target: Aim to have enough savings to pay one-third of your kids’ college costs by the time they start school.

Another third can be covered by current income, plus scholarships and grants from college, state, and federal programs. The final third can be funded with loans taken out by the student and parents.

When your child reaches high school, start scoping out schools that are likely to be affordable. Every school has an online net price calculator that will give you an estimate of your family’s share of the cost to attend.

By comparing the expected cost with your savings and income, you and your child can focus on a list of schools that are likely to be within your financial reach. Just remember that you won't find out the actual costs until your child is admitted and receives a detailed financial aid package

Explore All Sources of Funding

Make sure to apply for financial aid even if you think you won't qualify for need-based assistance. Half of families report getting scholarships and grants to pay for school, mainly provided from the college itself. But you won’t be considered for most aid unless you fill out the Free Application for Federal Student Aid (FAFSA).

You can apply as early as October of the year before your child plans to enter college and submit the FAFSA anytime during the school year he or she is enrolled. If your child has work-study or part-time job during the school year or a summer job, he or she could contribute several thousand dollars. Students can earn up to $6,500 a year without hurting their financial aid eligibility.

Borrow Strategically

There’s nothing wrong with borrowing—just don’t take on more than you can afford, says Kantrowitz. Stick to federally backed loans, which have fixed interest rates and more flexible payment options compared with private loans.

Your child should max out federal loans before you take on debt. Student loans are less expensive than Parent PLUS or private loans, and you don’t need a co-signer. Undergraduate student loan rates are set at 4.53 percent for the 2018-2019 school year vs. 7.08 percent for Parent PLUS loans. You can always help out on payments.

If you decide to borrow, here’s a good rule of thumb: Parents who use the standard 10-year repayment plan on federal loans shouldn’t borrow more than their annual income to cover all their children’s college costs.

And if retirement is less than 10 years away, you need to ratchet that down. If you’re just five years from the finish line, for example, don’t borrow more than half your annual income. 

Don’t Risk Your Retirement Assets

You might be tempted to take a loan from your 401(k), but it’s a costly move. Unlike the pretax money you use to fund the 401(k), you'll pay the loan back with after-tax money. You’re taxed again when you withdraw the money in retirement.

Then there's the cost of missing out on any growth on that borrowed money while you’re paying back the loan. And if you leave your job, you may have to repay the whole loan right away.

The IRS waives the 10 percent early-withdrawal penalty if you use IRA money for higher-education expenses. But you’ll still have to pay income taxes on the amount you withdraw, and that could bump you into a higher tax bracket. 

Be Careful About Tapping Home Equity

Taking a home equity loan may look attractive because you typically can get a much lower interest rate than with federal parent loans. Home equity lines of credit are 5 percent to 6 percent depending on how much you borrow and your financial picture, according to Bankrate.com, vs. the 7.08 percent percent PLUS loan rate.

But there are a lot of reasons to be wary of this option. The money you get from a home equity loan is counted as income and could make it harder for your child to qualify for financial aid.

It’s also a less attractive move under the new tax law that took effect in 2018. You are no longer allowed to deduct the interest on a home equity loan if you use it to pay for college.

There are a number of risks, too. You’ll use up valuable equity that you might want in retirement if you planned to sell your home and downsize. If you carry your mortgage into retirement, that’ll hurt your post-work budget. And if you have trouble paying the loan, you could lose your home.  

Want More Advice? Watch This Video

Paying for college isn't easy. Consumer Reports' financial expert, Donna Rosato, gives Jack Rico, host of the "Consumer 101" TV show, tips on how to maximize aid when paying for higher education.  



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