Borrowing for College: Beyond Student Loans

The cost of a college education continues to rise faster than the rate of inflation. Parents who want to help pay their kids’ way will find that the costs are much greater than when they attended college decades earlier. While kids study for placement exams, parents would do well to study up on ways to finance tuition.

According to Education Data Initiative’s Average Cost of College by State report, the average college tuition in the U.S. is $9,349 for in-state students and $27,023 for out-of-state students at public 4-year institutions. The nationwide, in-state room & board costs account for an additional $11,686 per year on average.

Many parents and students assume they will cover costs by applying for a subsidized federal student loan; however, families may have too much income or too many assets to qualify.

The government also offers unsubsidized federal loans, which are available regardless of need. But both subsidized and unsubsidized federal loans have limits. Dependent students can only receive $5,500 to $7,500 in federal student loans per year, with a lifetime limit of $31,000, according to the current guidelines published by the US Dept. of Education's Office of Federal Student Aid. That is clearly not enough to cover all of today's average education costs.

The loans discussed above are made in the student’s name; however, parents are free to make the payments on those loans or contribute toward them. Then there is the PLUS loan, a federal unsubsidized loan that parents can use to borrow up to the full cost of attending school.

For families that don’t qualify for subsidized loans, a common fallback plan has become a private student loan, a market that has grown steadily in recent years. But private student loans have drawbacks. They often come with variable or high fixed interest rates and can require a rigid payment plan. Depending on the lender, private loans may also have application, origination or prepayment fees.

Nearly every family should consider applying for financial aid, even if they think they earn too much to qualify, because both the government and schools themselves consider a number of factors when determining how much the family is expected to contribute to a child’s education cost. For instance, will the family have more than one child in college at the same time?

Homeroom, the official blog of the Department of Education, explains: “Having multiple children enrolled in college at the same time could have an impact on your children’s eligibility for need-based federal financial aid.” There are also thousands of scholarships students can apply for that are not need-based. In fact, 73% of all families used scholarships to pay some college costs in 2022-2023, according to Sallie Mae’s 2022 How America Pays for College study.

Even if you realize your family won't qualify for any aid, don't panic. Remember that there are other college financing options available.

Even after exploring other resources, families who don't qualify for or who max out their federal student loans may still find that they need to borrow money. The following loan types allow families to use their assets as collateral, so they’re typically priced lower than private student loans. They allow parents to continue enjoying the assets they've worked for while also using them to cover tuition.

If you have built up equity in your home over the years, you may be able to tap that to finance a college education. A cash-out refinance replaces your current mortgage with a new, larger mortgage, and pays you the difference as a lump sum. If your home has increased in value, you may qualify to borrow quite a bit more than you owe.

However, it’s important to look at the whole financial impact of refinancing. Consider the closing costs, for instance. It’s also important to decide whether to start fresh with a new 30-year mortgage, which will push out the date when your home is fully paid off, or to take a shorter loan that keeps your pay-off date the same, but may result in higher monthly payments.

Cash-out refinances have one big drawback for financing college: You get all the money up front, and must pay interest on it from day one, even though you won't need to pay for four years of college all at once.

Most borrowers are aware that they have the opportunity to borrow against the value of their home. Less well known are securities based loans (“SBLs”) which use eligible securities as collateral for a loan.

Interest rates for SBLs tend to be competitive, higher than mortgage rates but lower than student loans or second mortgages. SBLs are revolving credit lines so you can draw on them as needed for tuition payments.

SBL borrowers also enjoy payment flexibility. For instance, borrowers may be able to choose to start with interest-only payments and pay off the loan principal after the child finishes college, or tie their principal payments to cash flow events such as bonuses. Borrowers of course should carefully consider the costs involved with loans; for example, some SBLs require a prepayment fee to pay off principal early.

SBLs also offer a simple application process, without the lengthy paperwork required for student loans and mortgages. Also unlike student loans, which are generally recorded on credit reports, SBLs are not typically reported to credit bureaus.

Of course, borrowing comes with risks. When borrowing against a home, you should be aware that failing to make regular payments could risk foreclosure and the loss of the property. With SBLs, it's important to know that if the value of the stock securing the loan significantly declined, the lender could require you to either add capital to the collateral account quickly or liquidate the stock under unfavorable market conditions.

Morgan Stanley clients should talk with their Financial Advisor about all of the options available to help plan for a child’s education.

Borrowing against securities may not be appropriate for everyone. You should be aware that there are risks associated with a securities based loan, including possible maintenance calls on short notice, and that market conditions can magnify any potential for loss. For details please see the important disclosures below.