What if colleges had to post the all-in cost of tuition, room and board, including the total amount of extra expenses you incur when you take out a student loan? College costs are already unimaginable for many families, and listening to the horror stories, it would seem that borrowing for college is simply “the way things are.” But, it doesn’t have to be that way, and the numbers prove that it costs much less to save than it does to borrow.
The College Board, which annually collects nation-wide college tuition and financial aid information, reported recently in its Trends in College Pricing that the average cost of tuition, room and board for one year at a 4 year public college was just under $20,000 in for the 2015 – 16 school year, or $78,200 for the entire program (although we know college tuition is likely to rise annually). The same number for a private, non-profit 4-year college was $43,900, or $175,600 for 4 years.
These numbers are high, I won’t deny, and out of whack with what they used to be as a percentage of household income (see How Have We Slid So Far, Financially, in One Generation), but, borrowing money to pay for this only increases the burden.
The College Board further reported, in its Trends in Student Aid, that nearly 60% of students who earned bachelor’s degrees in 2013-14 from the public and private nonprofit institutions graduated with debt. They borrowed an average of $27,300. If this makes you think that taking out a loan for college is just part of the way the game is played, think again. That debt costs a lot of money, and there is no need to give your hard-earned money to someone else when you can keep it for yourself.
While taking out a loan to help pay for college seemingly eases what looks like an overwhelming cost, it actually, simply, makes college that much more expensive. Over time, a student loan of $27,300 could cost you an extra $7,400, (excluding any set-up or application fees), not to mention the additional $290 payment you’ll be making each month to the lender after graduation.
Why is it we feel we can make these payments in the future, or ask our children to take out the loans and make the payments out of their first paychecks, but, we can’t make them now?
This is a fundamental financial behavior – it’s hard to save now for something in the future, but, saving for college simply beats taking out loans in 3 important ways.
1. It simply costs less to save
Let’s say that your neighbor takes out a college loan for the average loan amount shown above of $27,300. Interest rates can vary anywhere from below 3% to as high as over 10%, depending on the lender, credit history, the school chosen and who is taking out and co-signing the loan. In addition, your neighbor can choose to begin paying back the loan while his child is still in school, or possibly take advantage of a deferred payment plan which allows a student to wait an additional six months past graduation to begin payments.
Sound confusing? That’s the first problem. Not everyone realizes that a deferred payment plan still means that interest is accruing and must be paid as part of the full loan payment after graduation (making your final loan payoff even greater). Additionally, re-payment programs can be confusing and complex.
But, let’s look at what it will actually cost your neighbor to pay off this loan. Making some reasonable assumptions that the loan is at 5% and is paid-off over 10 years, this $27,300 loan will end up costing him over $34,700 – an additional $7,400 with a monthly payment of $290.
On the other hand, if you turn the equation around and begin saving when baby is born, you can afford that school for less than $290 per month – and it will actually cost you a lot less overall. To reach the 4-year price of a public college ($76,000) you would only need to put away $225 per month starting the day your baby was born, to provide you with $76,000 on graduation day*. If you were to save $225 per month in a tax-efficient 529 Plan, the payments you would make into it ($225 x 12 months per year x 18 years) would only equal $48,600 – but, if they could grow at 5% per year, they could grow to $76,000 when it’s time to make the first college payment.
2. Shelter some tax dollars while you’re at it
When you make a concerted effort to save for college, the government helps you, making saving that much easier. The IRS code provides for a program called a 529 Plan. This program allows your investments to grow tax-free (reducing your federal taxes) as long as the savings are used to pay qualified education expenses (now you’ve saved money twice).
529 Plans are available to everyone, there are no income limits, although gifting rules apply to the amount you can invest each year. Opening a 529 account should be very easy, choosing the right one may be the hardest part (see What You Need to Know before Choosing a 529). Once you have an account you can contribute up to the gifting limits each year, even birthday money and other gifts can be added to help it grow.
3. You may also save at the state level
And, some states even allow you to deduct any contributions you make to a 529 plan, further reducing your state taxes (now, you’ve saved three times while saving for college!). See this State Tax 529 Calculator from SavingforCollege.com to see what your state offers.
Saving to pay yourself really is better than paying out all of that interest to someone else. Take a few moments right now to check out your budget and determine how much money you can devote to your child’s education today.
* Assumptions: Investments grow tax-free at 5% for 18 years.