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From choosing a major to touring different schools, planning for college can be an exhilarating time. There are so many new experiences waiting, and often, high school graduates can’t wait to step foot on campus.
There is, however, one part of the college planning process that isn’t so fun: Figuring out how to pay for it.
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College is expensive, and figuring out exactly how to pay for it can be a daunting task. From financial aid to student loans, it’s easy to feel overwhelmed about all of the options available to you.
To make it a little easier to understand, we wanted to take some of the most popular options and distill them down to their most basic so that you (and your parents) can make the best decision for your unique financial situation.
1. Using a 529 Savings Plan to pay for college
A 529 plan is a tax-friendly savings program specifically designed for college. Its name comes from Section 529 of the tax code—which gives tax-free status to qualified tuition programs.
Each state administers its own 529 program and there are two types: Education savings plans and prepaid tuition plans.
Education savings plans, in short, allow parents and guardians to save for their children’s education with a variety of investments. The money can be withdrawn from the account to pay for college expenses like tuition and room and board. Prepaid tuition plans, on the other hand, allow parents and guardians to purchase credits for college in advance—allowing them to save if the cost increases over time (which it likely will).
The pros of using a 529 College Savings Plan
The benefits of using a 529 college savings plan will depend on which type you use: Education savings plans or prepaid tuition plans.
Education savings plans are great because they allow parents to begin saving and investing for their child’s future, which lets the money grow over time. The other main advantage of education savings plans is that holders can withdraw money from the account without paying taxes—much like a Roth 401(k) or Roth IRA, allowing your money to go even further.
Prepaid tuition plans, as mentioned, save money because credits are purchased now, at today’s prices, which are very likely to be lower than they will be in the future. They are, essentially, a hedge against inflation.
The cons of using a 529 College Savings Plan
The biggest drawback to a 529 plan is that, like all investments, the account’s value is dependent on the market. This means that you could potentially lose money depending on how the market performs. While it’s not likely, it is possible that a market crash could substantially decrease your investment at a time when you were planning on using it. That’s why it is important to understand your investment timeline and to make sure your allocation grows more conservative as you get closer to needing your funds.
Another con? Though, yes, you could open your own 529 savings plan, in most cases, these plans are opened and funded by your parents. If your parents can’t afford to fund a 529 savings plan for you, and you’re unable to do so yourself, then you won’t have access to college savings. This isn’t a con per se, but an important thing to keep in mind.
Luckily, even if your parents can’t help you pay for college, there are other ways that they can help you out.
If you and your parents start early enough, a 529 plan can be a great way to save, invest, and pay for college. The key is to starting early, as this will give your money the most time to grow, while also enabling your balance to recover from any short-term volatility or losses.
2. Using scholarships to pay for college
Scholarships are free money that you can use to pay for your education, that doesn’t need to be paid back. The money can come from a lot of sources—your high school, college, or some other organization—for a lot of reasons. The most common reasons scholarships are granted are due to academic or athletic excellence, but others may be granted to individuals with certain ethnicities or to those who plan to study specific subjects.
Each scholarship has it’s own eligibility requirements and applications process, so you’ll need to do some research to find the ones that you should apply to. But you should definitely apply: Why would you pass on free money?
The pros of using scholarships
Scholarships are free money that you don’t need to pay back. Every dollar that you get in scholarships is one more dollar that you don’t need to borrow and pay back in the form of student loans. Plus, a number of scholarships are very competitive, and winning them comes with bragging rights that can help you stand out in college applications.
The cons of using scholarships
Like we just mentioned, scholarships are often very competitive: You’re one of many students trying to get a limited amount of free money. That means you’ll have to put the time and effort into making sure you have an outstanding application.
It’s also worth keeping in mind that you ultimately have little control over whether or not you ultimately earn a scholarship. You can work hard and write a killer application, but in the end, someone else makes the decision as to whether or not to give you the money. This makes it hard to predict how much money (if any) you’ll get in scholarships, and that means you can’t plan on paying for college through scholarships alone.
As free money, you would be a fool to pass up on scholarships. Apply for all of the scholarships that you can, and start as early as possible to give yourself the best chances of earning some free money. But make sure you have a backup plan: If you don’t earn any scholarships, you’re going to need to find another way to pay for college.
3. Using grants to pay for college
Grants are like scholarships in that you don’t have to pay them back: They, too, are free money. Where they differ is in their eligibility requirements. While scholarships tend to be awarded for merit, grants are typically given for financial need. Usually, the more financial need you have, the more grants you’re likely to be eligible for.
The pros of using grants
Most grants are given to students automatically as a result of your financial need from the results of the FAFSA—so you won’t have to go through an application process. It’s as easy as that! And again, just like scholarships, you never need to worry about repaying grants: They’re free money, which can save you thousands of dollars compared to relying on student loans.
The cons of using grants
There really are no negatives to using grants to pay for college. But it’s really important to keep in mind that grants are dependent on your financial need, which is determined by your FAFSA application. If you don’t complete it, you won’t be eligible for many grants. Plus, if you don’t have high financial need, you may not be eligible for any grants at all to help you pay for college. The goods news, though, is that most states, universities, and the federal government all make it easy to know where your family falls on the financial need spectrum, which will help you plan and find other sources of funds if necessary.
If you have documented financial need, then you should be looking into grants; not just the ones that are awarded automatically, but state-based ones that are offered to specific fields of study or for other criteria. Free money is free money, after all!
4. Using a savings account to pay for college
Some parents (or students) may choose to use a standard savings account at their bank to save for their child’s college expenses as opposed to a 529 college savings plan.
The pros of using a standard savings account
If you and your parents opt to use a 529 college savings plan to save for college, you have the potential to really grow your money over time. But depending on how risky your asset allocation is, it is also possible to lose money, especially in the short term. This can be catastrophic if you the market tanks just before you need the money to pay for college.
With a savings account, you don’t have to worry about the market tanking and wiping out your investment. Every dollar that you put into your savings account will be there when you want to withdraw it, and you’ll likely have a little extra due to whatever interest you earn from the bank. And of course, compared to a 529 plan or a brokerage account, with a savings account you’ll have instant access to your money, without needing to cash things out or wait for funds to be available.
The cons of using a standard savings account
Savings accounts offer a lot more stability than 529 college savings plans, because you aren’t invested in the market. This means that if you keep your college savings in a savings account, there is little risk that you’ll lose any money. But there’s a good chance that you’ll lose buying power due to inflation.
Savings accounts, especially right now, have notoriously low interest rates and returns compared to investment accounts. This makes it very difficult for your money to keep up with inflation, which means that over time, the power of your money to buy things (or pay for college) will fall. That’s the tradeoff for high stability: Low returns.
Also, while 529 savings plans are tax-advantaged, standard savings account are not. And of course, the easy access can also work against you if you lack self-discipline; you could end up spending it on something other than education.
Honestly, as long as you can stomach a little volatility in the market, you’re better off using a 529 college savings plan compared to a standard savings account. Even a conservatively-allocated portfolio will likely outperform the low interest rates on today’s savings accounts. And the tax advantages of the plans will help your money go even further in paying for college.
If you do choose to use a regular savings account to pay for college, make sure that you:
- Put the funds in a high-yield savings account so that you can at least keep pace with inflation and preserve the buying power of your money
- Keep the finds separate from your other savings (just like you would with an emergency fund)
- Don’t be tempted to use the funds for anything else besides college expenses
5. Using federal student loans to pay for college
By filling out the FAFSA, you will receive a financial aid package that outlines what sorts of financial aid you are eligible for. Depending on your financial need, this may include scholarships or grants, and very likely will include federal student loans.
Federal student loans come in a number of types—from Perkins Loans to Direct Loans to PLUS Loans—each type with its own eligibility requirements, interest rates, and specifics. If you rely on student loans of any type (federal or private) you’ll need to ultimately pay back the amount that you borrow plus interest, so that’s an important thing to keep in mind. Student loans are not free money.
The pros of using federal student loans
Compared to private student loans, federal student loans come with a lot of benefits, including:
- A six-month grace period after graduation before you need to begin making payments
- A number of repayment options
- The possibility of student loan forgiveness or discharge
- The possibility of subsidized student loans (which can save you a lot of money in interest payments)
- The ability to place your loans in deferment or forbearance if you can’t make your student loan payments
The cons of using federal student loans
Federal student loans, as loans, of course need to be paid back with interest, which makes them less favorable than free money like grants, scholarships, or savings. Unless you make extra payments or refinance them, you will be repaying your loans for the next ten years or more. Finally, if you stop making your student loan payments, your credit can be negatively affected which can affect other aspects of your financial life.
If you have access to free money like scholarships and grants, you should use those before turning to any kind of student loan. But compared to private student loans, federal student loans are definitely the better bet.
6. Using private student loans
Sometimes, you may discover that your financial aid package does not fully cover all of your college expenses. In these cases, if you are unable to cover the gap out of pocket, you’ll likely need to turn to private student loans in order to finish paying for college.
Private student loans are loans that are offered by banks, credit unions, and other lenders, directly to borrowers. Because they’re not backed by the government and are dependent on creditworthiness, you’ll often see a higher interest rate and a lot less flexibility in repayment than with federal loans.
The pros of using private student loans
Private loans can help bridge the gap between your financial aid package and your cost of attendance, and you can typically use them for any and all expenses that you have during your time at college.
The cons of using private student loans
As mentioned, private student loans are a lot more expensive than federal student loans—often substantially more expensive.
Private lenders also have final say over who they lend to. This is often determined by your creditworthiness (as shown by your credit score). If you have low or no credit, you may be rejected unless you apply with a cosigner. Additionally, private lenders typically offer stricter repayment terms fewer less protections as compared to federal loans.
You should only turn to private student loans if you have no other options available to you. Before looking into these, you’ll want to make sure you have exhausted all other options.
The Bottom Line
There are many different options when it comes to paying for college. What’s best for you will depend on what your personal situation is, including your financial need, creditworthiness, and how much help you can expect from your family. But generally speaking, you can save yourself a lot of money by making sure you always accept your financial aid in the correct order, and by avoiding private student loans unless you have no other options available.