Deciding which loans are best for the family depends on these different factors:

1  Who will repay the loan

2  Repayment terms

3  Tax bracket

4  Cost of getting the loan

There are two loans the dependent student is legally obligated to repay: the Stafford and the Perkins loans. Any other loans are the parents’ responsibility unless they have jointly co-signed a private loan from a commercial lender.

Federal Loan Programs

These are the Perkins, Stafford, and PLUS loans, all of which have very good repayment terms and interest caps. Currently the repayment period for federal loans is 10 years.

Here is what the monthly payments would look like:

Besides the standard payments available, there are other repayment options available. The family can consolidate loans and stretch payments out over 20 years. There are graduated repayment plans which have smaller payments in the earlier years and gradually increase over time (these have higher interest costs).  Income contingent plans base the amount of payment on the level of income of the student after graduation. As income rises or falls so does the amount of payment.

Home Equity

Another viable alternative is a home equity line of credit where the family borrows only what they need, when they need it, paying interest only on the amount that’s borrowed. There is a minimum monthly payment, and the interest is normally tax deductible, but also variable.

*Make sure to compare the benefit of a federal loan vs. a home equity line of credit.  For example, a federal loan at 6% is equal to an equity line at 8.3% for someone in the 28% tax bracket because of the tax deductible nature of the equity line interest.

Second Mortgage

With a second mortgage a fixed amount is borrowed, and there is generally a fixed interest rate and repayment schedule. While it provides for a more consistent budget plan, the family is paying interest on money before it’s needed and have higher payments before it’s necessary.

401(k)

In some cases borrowing from the parents 401(k) retirement account is

possible. There are federal limits on the amount that can be borrowed.  Also,

the loan must be repaid in 5 years or stiff tax penalties apply as it becomes reportable as a premature distribution if the owner is under 59 ½ years of age.

Life Insurance Policy

Borrowing against the cash value of life insurance policies is another option. The repayment terms are often very lenient and may provide the option to only repay the interest. The loan may affect the death benefit and the interest rate earned by the remaining cash value.

*Remember that with every loan there are processing fees. These charges should be considered as well when comparing loans.