Use 401K for College? The PLUS Loan or Cosigning a Private Student Loan May Be a Better Option!
Q: My parents have agreed to help me pay for college. However, we do not have a 529 college savings plan, so my parents are looking for ways to get the money they need.
They do not have enough mortgage equity for a home equity loan, so they are considering taking some money out of their 401K account.
Is it a good idea to pay for college with 401K funds?
A: Normally, it is a very BAD idea to take funds out of a 401K retirement account to pay education costs. Tapping into a 401K for education should be a last resort only.
The thing your parents need to keep in mind is that they will probably need all of the retirement funds they have. And while you can borrow money for education expenses, it is impossible to take a loan for retirement expenses.
401K funds are not designed for the purpose of education financing and there may be heavy penalties for early withdrawal of any money from that account.
Depending on the 401K plan, it may be possible for your parents to apply for a loan from their 401K account provider, but even this can be an expensive option.
So what is a better option?
Consider the Federal PLUS Loan for Parents
The Federal PLUS Loan for Parents allows parents to borrow up to 100 percent of education costs for a dependent child. These costs can include tuition, fees, housing, books, lab materials, and even transportation.
And unlike a home equity loan or 401K loan, the interest rate is fixed for the life of the loan and no collateral is put at risk.
Better yet, parents can qualify regardless of their income, assets, or credit score. Even millionaires can qualify for this loan!
Benefits of the PLUS Loan:
- Covers 100 percent of education costs not met by other sources of aid
- Comes with a fixed interest rate
- Parents with low credit scores can qualify
- Parents with high incomes can also qualify
- Repayment can be delayed until after graduation
- Offers a choice of repayment options
- Student loan interest payments may be tax-deductible
Below is some more information that every student should know about the PLUS Loan:
How can my parents get a PLUS Loan?
Parents can borrow a PLUS Loan to help pay your education expenses if you are a dependent undergraduate student enrolled at least half time in an eligible program at an eligible school. PLUS Loans are available through the Direct Loan Program. Your parents must have an acceptable credit history. This means that your parents cannot have any bankruptcies, discharges, or loan write-offs.
For a Direct PLUS Loan, your parents must complete a Direct PLUS Loan application and promissory note, contained in a single form that you get from your financial aid office.
Also, your parents generally will be required to pass a credit check. If your parents do not pass the credit check, they might still be able to receive a loan if someone, such as a relative or friend who is able to pass the credit check, agrees to endorse the loan. An endorser promises to repay the loan if your parents fail to do so. Your parents might also qualify for a loan without passing the credit check if they can demonstrate that extenuating circumstances exist. You and your parents must also meet other general eligibility requirements for federal student financial aid.
How much can parents borrow?
The yearly limit on a PLUS Loan is equal to your cost of attendance minus any other financial aid you receive. If your cost of attendance is $6,000, for example, and you receive $4,000 in other financial aid, your parents can borrow up to $2,000.
Who gets the loan money?
The U.S. Department of Education will send the loan funds to your school. Your school might require your parents to endorse a disbursement check and send it back to the school. In most cases, the loan will be disbursed in at least two installments, and no installment will be greater than half the loan amount. The funds will first be applied to your tuition, fees, room and board, and other school charges. If any loan funds remain, your parents will receive the amount as a check or in cash, unless they authorize the amount to be released to you or to be put into your school account. Any remaining loan funds must be used for your education expenses.
Other than interest, is there a charge to get a PLUS Loan?
Your parents will pay a fee of up to 4 percent of the loan, deducted proportionately each time a loan disbursement is made. For a Direct PLUS Loan, the entire fee goes to the government to help reduce the cost of the loans. Also, your parents may be charged collection costs and late fees if they do not make their loan payments when scheduled.
When do parents begin repaying the loan?
Normally, repayment will begin six months after the dependent student on whose behalf the parent borrowed ceases to be enrolled on at least a half-time basis.
How do parents pay back these loans?
Parent will repay their Direct PLUS Loan to the U.S. Department of Education Direct Loan Servicing Center.
Is it ever possible to postpone repayment of a PLUS Loan?
Yes, under certain circumstances, your parents can receive a deferment on their loans. If they temporarily cannot meet the repayment schedule, they can also receive forbearance on their loan, as long as it is not in default. During forbearance, their payments are postponed or reduced.
Generally, the conditions for eligibility and procedures for requesting a deferment or forbearance apply to both Stafford Loans and PLUS Loans. However, since all PLUS Loans are unsubsidized, your parents will be charged interest during periods of deferment or forbearance. If they do not pay the interest as it accrues, it will be capitalized (that is, added to the principal amount of the loan, and additional interest will be based on that higher amount).
Can a PLUS Loan be discharged (canceled)?
Yes, under certain conditions. A discharge (cancellation) releases your parents from all obligation to repay the loan.
Your PLUS Loan cannot be canceled for these reasons: You did not complete your program of study at your school (unless you could not complete the program for a valid reason -- because the school closed, for example), you did not like the school or the program of study, or you did not obtain employment after completing the program of study.
For more information about loan discharge or repayment: If your parents have a Direct PLUS Loan, they should contact the Direct Loan Servicing Center at 1-800-848-0979, or go to studentaid.ed.gov. If they have a FFEL PLUS Loan, they should contact the lender or agency holding the loan.
Looking for another option? Consider acting as a cosigner on a private student loan. You may be able to use your good income and credit history to help a student qualify for a private student loan with a good interest rate.