Despite calls for America's colleges to slow down tuition increases, the cost of post-secondary education continues to rise. Published tuition and fees at private schools rose by three percent in 2018-19 over the previous year to an average annual tuition of US$35,676, according to US News & World Report. But many schools charge far more than that, according to a report by The College Board.
With many Ivy League schools charging upwards of $60,000 a year for tuition, students and their families could find themselves paying close to $400,000 in total expenses over a four-year span – and that's just for one child. As tuition and room-and-board costs climb, even high-net-worth families may find it increasingly difficult to fully fund four years of college expenses.
Those who haven't set enough money aside for education must find other ways to pay for college. In many cases it's simply a matter of timing. It might mean college expenses are funded over five years instead of four. Parents should also be mindful about not liquidating investments during periods when the market is down and having a ready line of credit, which can help make these cash-flow challenges easier to navigate.
Tap into lines of credit
One popular option for paying tuition is borrowing against established equity lines, including home equity lines of credit (HELOCs) and securities-based lines of credit. Both allow families to borrow cash to make tuition payments at a typically lower interest rate than a traditional loan.
“While it's best to have saved and be financially prepared for college, one choice if you are looking to borrow money might be a securities-based line of credit," says Fred Rose, head of credit and liquidity solutions for RBC Wealth Management. “Not only can these lines of credit have a low interest rate, typically four to six percent, but they're not amortizing loans, so they offer flexibility."
The benefits of securities-based lines of credit
Rose points out cash flow is extremely important to people in the typical 50-to-60-year-old age range. This age demographic usually encompasses parents of college students who have high incomes, high expenses and a 10-to-15-year timeline to retirement.
For many high earners, Rose explains, the majority of their income typically comes in the form of a year-end bonus or periodic distribution from their business or partnership.
Securities-based lines of credit also have interest-only payment options. Borrowers can choose to pay off the loan principal with their year-end bonus or invest the bonus and keep the loan longer with monthly interest-only payments, Rose says. This differs from traditional loans with short-term amortization schedules, which typically leads to high mandatory interest and principal payments.
Another option is a home equity line of credit.
How does a HELOC work?
“You could have both a securities-based line of credit and a HELOC for liquidity," says Rose. “HELOC interest rates are slightly higher than the rates for a securities-based line of credit."
The amount you can borrow with a HELOC is capped, says Rose. Homeowners typically can only borrow up to 80 or 85 percent of the value of their home, including their first mortgage and any other debt secured by the property.
“The amount you can borrow with a securities-based line of credit floats according to the balance in your portfolio," says Rose. “Typically, you can borrow 60 to 70 percent of your equity investments and a little more of your bond investments. But it might be wise to borrow less than 50 percent of what you're allowed to borrow."
While HELOCs and securities-based lines of credit may be preferable to other loan options, they aren't completely risk-free, says Rose. Every borrower needs a plan in place to repay these loans.
Just like wine and chocolate, Rose says, each can have clear benefits, but over-consumption creates risk.
“For example, if you max out what you can borrow, you run the risk of having to sell assets or your home to pay down the balance at an inopportune time," he says.
Another reason Rose suggests someone might want to use a line of credit is if their savings earmarked for tuition are in the form of assets outside of a 529 plan.
“It may be better not to liquidate those assets at a particular time because of the market or because you could trigger capital gains taxes," Rose says. “It's always smart to look at your entire financial picture before making a decision."
Apply for traditional loans
Just because there is family wealth, that doesn't mean a child doesn't qualify for any loan assistance. Interest rates are higher on private student loans than on lines of credit, but they are another option, says Paul DeLauro, senior vice president and manager of wealth planning for City National Bank.
Many people think the Parent PLUS loan, a federal loan program for parents of dependent undergraduate students, is income-tested, but it's not — it's credit-tested, says Kal Chany, author of Paying for College Without Going Broke and founder of Campus Consultants, a company that helps students with financial aid. However, these loans usually have a higher interest rate than a line of credit. For the 2019-2020 academic year, Parent PLUS loan rates are set at 7.08 percent (fixed rate).
In addition, most educational institutions offer merit-based scholarships for which anyone can apply. In some cases, you'll have to apply for financial aid and get rejected before you can apply for the merit-based award, Chany says.
Saving early is the best approach
Of course, the best way to pay for college is to start saving early, says Chany, adding it's never too late to put money into a 529 Plan. When trying to save, don't forget about travel and living expenses for your student, which can add up to about half the tuition costs, adds DeLauro. “Many people only look at tuition and then find out they haven't saved enough," he says.
It's also a good idea to develop a family philosophy around college tuition, says Angie O'Leary, head of wealth planning at RBC Wealth Management-U.S., especially for high- net-worth individuals. Decide on who's paying — are the parents covering everything? Or should the children contribute too, necessitating they work while pursuing their education?
Understanding who will be accountable for what can influence the kind of credit used to fund a child's education. Maybe the child pays, but the parents loan them money from their equity line of credit and charge the child a lower rate. “You have to think through all the options and decide, as a family, what makes most sense," says O'Leary. “Figure out together how best to pay."
Securities-based loans involve special risks and are not suitable for everyone. You should review the provisions of any agreement and related disclosures, and consult with your own independent tax and legal advisors about any questions you have prior to using securities-based loans or lines of credit. Additional restrictions may apply.
RBC Wealth Management, a division of RBC Capital Markets, LLC, is a registered Broker-Dealer, Member FINRA/NYSE/SIPC, and is not a bank. RBC Capital Markets, LLC, its affiliates and their employees do not provide tax or legal advice. Lending services may be offered by bank affiliates of RBC Wealth Management. RBC Wealth Management and/or your financial advisor may receive compensation in conjunction with offering or referring these services.
City National Bank is an affiliate of RBC Wealth Management.
Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested.