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How to pay for college

Got a shortfall? Five key questions to consider to help you fill a college funding gap.

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Getting into college is cause for celebration, but paying for it is a different story. The annual cost of a four-year, public, in-state college for tuition, fees, and room and board averaged $18,291 for the 2013–2014 school year, while costs at a private college averaged $40,917, with some schools topping $60,000, according to the College Board.1

In an ideal world, you’d have a fully funded college saving plan ready to pay those bills. But if that’s not you, you’re not alone. Parent savings and income cover only a quarter of college costs, according to a 2013 Sallie Mae study.2

How do you fill the gap? For some students, grants, scholarships, and work-study programs can help. But for most, borrowing is key. Seventy percent of last year’s graduates left college with some student debt.3 The College Board puts the typical debt burden between $24,000 and $30,000.

Your college ROI

But is the return on your college dollar worth the investment? Nearly 40% of students surveyed by Fidelity4 said they would have made a different college choice and pursued different savings strategies had they understood the consequences of the debt they were shouldering.

Don’t make that mistake. Before saying yes to any college, sit down with your family and consider the following five questions to determine whether your college ROI makes sense for you—and how to fill any funding gap.

1. How much debt can you really afford?

Before accepting a financial aid package that includes student loans, you should think carefully about your ability to repay this debt after graduation. When you purchase a home, your lender helps with this analysis, but with student loans, that responsibility falls on you.

Keep in mind that different careers offer substantially different earnings potential. Do you plan to be a software developer or engineer? You may be able to afford to take on more debt than your friend who aims to be a teacher. Using assumptions including future earnings by major, Fidelity’s John Colantino, CFP®, vice president for financial solutions at Fidelity’s Strategic Advisers, developed the chart below.

Before you start visiting college campuses, make sure you sit down with your family and create a realistic financial plan that covers earnings potential, job prospects, college costs, financial aid eligibility, and future student loan debt. Don’t forget to factor in the cost of postgraduate study if this will be required, as well as your willingness to make spending adjustments during and after college.

2. Are you making the most of financial aid?

While 70% of American families receive some financial aid, not all of it is “free” money. On average, close to 40% of aid packages involve loans that will have to be repaid. Because the breakdown between free aid and loans varies by college and the financial situation of the student, it’s important to understand the aid process and how to improve your eligibility.

Typically, a student aid package requires an expected family contribution (EFC) that the government will calculate for you when you apply for financial aid. Your EFC represents the amount you and your family would be expected to fund yourselves. Any difference between this amount and the cost of college may be covered by financial aid. If your child is close to college age, use the free College Board EFC calculator to get an estimate. Another good idea is to explore financial aid information from the colleges your student is considering, as well as taking advantage of the net price calculator available on their respective Web sites.

For a quick approximation of your potential annual aid award using the federal methodology, Fidelity suggests this rule of thumb: If your household income is less than $100,000, subtract 10% of your income from a college’s cost; if your income is greater than $100,000, subtract 20%.

For information on how to potentially help minimize your EFC and maximize potential financial aid, read Viewpoints: “Get a head start on college.”

3. Are you getting the most out of your student loans?

Generally, there are three types of student loans provided as part of a financial aid package—federal student loans, state-sponsored loans, and private student loans. Your goal should be to find the least expensive loans, because even a couple of interest points can make a big difference in how much debt you will have to pay back.

  • Federal loans, provided directly through the U.S. Department of Education, offer more flexible payment options and interest rates, and may even pay the interest while you are in school. Don’t overlook these loans or assume that your income is too high to qualify. The application process is straightforward and can provide even middle- and upper-middle-class households some relief.
  • State loans have your state’s stamp of approval and vary from state to state, as do their interest rates. Some states offer attractive features like fixed rates. Others do not tie rates to your credit score.
  • Private student loans are made through banks, credit unions, or the schools themselves, and offer both fixed and variable rate options. In general, students should rely on private loans as a last resort, because they tend to charge higher interest rates and often have more stringent rules about paying them back.

For detailed information about student loans, visit our Student loan guide.

4. Have you weighed parent borrowing options?

Parental borrowing is also a way to pay college costs, but be careful. First, try to make sure this debt will not affect your retirement savings. Remember, you can borrow for college, but you can’t use a loan to fund your retirement.

One popular way to fund some or all the difference between a student’s financial aid award and the cost of college is a Parent Loan for Undergraduate Students (PLUS). With a PLUS loan, the U.S. Department of Education is the lender and loans are made available to parents without having to demonstrate financial need. PLUS loans usually have a higher interest rate than federal direct loans, but they offer a fixed rate that is usually less expensive than private loans. Loan terms can range from 10 to 30 years.5

Tapping into home equity is another option. Home equity loans generally offer a fixed interest rate, averaging 6.79% for a $30,000 loan; a home equity line of credit (HELOC) carries a variable interest rate averaging about 4.61%, according to Bankrate.com as of May 2014. The advantage over education loans is that interest on home equity loans and lines of credit is deductible up to $100,000 for debt taken out to pay for college. However, both types of loans use your home as collateral, so it can be lost if the terms of repayment go unmet.

Also, be aware that the money received through a home equity loan is considered an asset once it is deposited into your checking or savings account and will raise your family’s EFC. If this is a concern, you may want to rely on a HELOC instead of a home equity loan, and pay college bills as soon as you receive the money, which will not affect your EFC.

Withdrawing or borrowing from retirement accounts is another option, but saving for retirement should generally be considered the primary consideration. If you withdraw from retirement accounts, do so with caution. You may inadvertently imperil your retirement plans if you’re not careful. That said, there are some advantages. If you use an IRA distribution to pay for college expenses before you’re age 59½, you’re generally exempt from the 10% early withdrawal penalty. And if your withdrawal consists of contributions (rather than earnings) from a Roth IRA, those contributions are usually not subject to taxes.

Such is generally not the case if you withdraw money from your 401(k), unless you qualify for a hardship withdrawal. To qualify, you’ll have to demonstrate an immediate financial need and show that other financial resources have been exhausted. Also, there may be fees. And if you leave your job, the loan balance is considered a withdrawal, and taxes, penalties, and fees may apply. Check with your employer for specific details on your company’s plan.

While withdrawing from your retirement account avoids interest rates on loans, don’t overlook the potential for growth that will be lost and difficult to recapture. Also, the amounts withdrawn may count as income for EFC purposes, which may affect eligibility for need-based financial aid during the next year.6

5. Have you revisited your investing strategy?

Over the years, you have probably invested a significant portion of your college savings portfolio in equity investments to take advantage of their potential for growth and provide the opportunity to keep pace with rising tuition costs. But if college is just a few years away, you may want to consider adjusting your asset allocation to a more conservative mix. This way, you reduce your risk if a large stock market downturn happens just as you need the money for college.

Get help

Paying for college is a balancing act, because it requires that your savings, taxes, income, and financial aid eligibility all work to your advantage. Before making any financial moves, consult your financial, college planning, or tax adviser.

Learn more

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The tax and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
1. Source: The College Board.
2. Conducted by Ipsos Public Affairs for Sallie Mae.
3. Sources: The College Board and National Center for Education Statistics.
4. About the 2013 Fidelity College Savings Indicator: As part of the study, Fidelity conducted a survey of parents with college-bound children of all ages. Parents provided data on their current and projected household asset levels, including college savings, use of an investment adviser, and general expectations and attitudes toward financing their children’s college education. Using Fidelity’s proprietary asset liability modeling engine, the company was able to calculate future college savings levels per household against anticipated college costs. The results provide insight into the financial challenges parents face in saving for college. Data for the Indicator (number of children in household, time to matriculation, school type, current savings, and expected future contributions) were collected by Research Data Technology, an independent research firm, through an online survey of more than 2,500 parents nationwide with children aged 18 or younger who were expected to attend college. The survey respondents had a household income of $30,000 a year or more, and were the financial decision makers in their household. College costs were sourced from the College Board’s Trends in College Pricing 2012. Future assets per household were computed by Strategic Advisers, Inc. (a registered investment adviser and a wholly owned subsidiary of FMR LLC). Within Fidelity’s asset liability model, Monte Carlo simulations were used to estimate future assets at a 75% confidence level. The results of the Fidelity College Savings Indicator may not be representative of all parents and students meeting the same criteria as those surveyed for this study.
5. Source: The College Board.
6. Source: IRS.
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