Family Finances

Back To School

Weathering the college-tuition perfect storm

by Angie O’Leary

Ms. O’Leary is head of wealth planning for RBC Wealth Management – U.S. Visit www.rbcwealthmanagement.com.

College costs are top of mind right now, as students have settled into their work on campus and President Joe Biden’s recent announcement of the cancellation of up to $10,000 in federal student loan debt (up to $20,000 for recipients of Pell Grants) for borrowers making less than $125,000 annually and couples earning less than $250,000 per year.

While debt forgiveness brings relief to many who are currently repaying federal student loans, families across the country are still wrestling with how to cover tuition for the year. At a time when the cost of tuition is on the rise, 529 savings balances have taken a market hit and interest rates have spiked, making student loans more expensive—it’s a perfect storm.

Tuition Sticker Shock

For many parents, college is a big ticket expense that they have diligently been saving for, but may not have saved enough. For the past decade, education inflation has outpaced core inflation by a factor of two, averaging around 8%. That first tuition bill is likely a rude awakening.

Published tuition and fees at private schools rose in 2021-22 to an average annual tuition of US$55,800, according to The College Board’s 2021 Trends in College Pricing report. But many schools charge far more than that. In contrast, the average 529 account balance was $30,287 in 2021, according to the College Savings Plans Network, leaving a significant funding gap.

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.

In addition, those who haven’t set enough money aside for education must find other ways to pay for college. In the case of multiple children cycling through college, many families, like mine, have the first kid covered, the second child partially covered and the third child covered for only a few semesters.

Timing is everything and a down market is not your friend when it comes to funding college by tapping into a depressed 529 account. It may make more sense to tap into short-term liquidity alternatives, like paying cash or borrowing from a security-based or home equity line of credit. The idea is to cover tuition today with other means while letting the market recover some or all of your 529 balance, then you cash-out and pay off the loan.

College Bridge Loans

Liquidity is important in managing market cycles. 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 for tuition payments at a typically lower interest rate than a traditional loan. These loans are not amortizing loans, so they offer flexibility in how much and when they are paid back. For some parents, a year-end bonus might help to pay down the loan balance.

How Does Securities-Based Lending Work?

Securities-based lines of credit provide ready access to capital that can be used for almost any purpose, including college expenses. The only restriction is that the funds can’t be used to buy more securities or to pay off a margin loan.

Here the borrower is using the non-qualified marketable investments as collateral for the loan. Typically you can borrow 50% to 70% of the value of your portfolio, depending on the types of eligible securities you hold. It is an interest-only loan, so there is no requirement to pay down the principal until you choose to pay it down. This differs from traditional loans with short-term amortization schedules, which typically leads to high mandatory interest and principal payments. Securities-based lending has become a popular choice because it tends to be easier to obtain and requires far less documentation than a traditional loan or home-equity line. Once the line is established, the funds are typically available in a day or two.

How Does A HELOC Work?

HELOC interest rates typically are slightly higher than the rates for a securities-based line of credit, and the amount you can borrow is capped based on your home value at the time the line was established plus any outstanding mortgage. It is increasingly common to establish a line of credit along with your mortgage if you have a significant equity position in your home. This was especially popular when refinancing was in vogue during this past decade. Not surprisingly, there is more paperwork and fees with a HELOC. But once established, you can withdraw funds when you need it, you pay monthly interest and you have flexibility in paying off the principal.

For the past decade, education inflation has outpaced core inflation by a factor of two, averaging around 8%. That first tuition bill is likely a rude awakening...

Keep in mind that you could have both a securities-based line of credit and a HELOC for liquidity options. While HELOCs and securities-based lines of credit may be preferable to other loan options, they aren’t risk-free. Every borrower needs a plan in place to repay these loans.

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.

Traditional Student Loans

Family wealth doesn’t mean that a child won’t qualify for loan assistance. Interest rates are typically higher on private student loans than on lines of credit, but they are another option. The Institute for College Access and Success has reported that nearly 70% of college students nationwide borrow money to help pay for school-related expenses. Interest rates for federal student loans, which are issued by the government, are currently set once per year and are fixed at 4.99% for the 2022-23 school year.

Private student loans, which are issued by various types of financial institutions, tend to have interest rates that are higher than federal direct student loans, and those rates can be fixed or variable. Typically, there is low to no interest while the student is in college with repayment over 10-to 15 years. A student loan also has the added benefit of putting some ownership in the student’s hands when it comes to funding their education. Our family did this and then helped to pay off the loan once each student graduated. This allowed us to stretch the financing as our cash flow allowed.

Some colleges offer creative financing plans, such as prepayment of four years’ tuition, based on the current rate, which might be helpful if you are concerned about inflation.

Of course, the best way to pay for college is to start saving early. It’s never too late to put money into a tax advantaged 529 plan. But it might be equally important to be strategic about how to pay that tuition bill when it arrives. When thinking of how much to save, don’t forget about travel and living expenses for your student, which can make up a significant portion of college costs. Many people only look at tuition and then realize they haven’t saved enough.

It’s also a good idea to develop a family philosophy around college tuition, especially for high-net-worth individuals. Decide on who’s paying — are the parents covering everything? Are grandparents contributing? 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.”

 

 

 

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.
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.

RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.

 

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