There is an economic benefit to build and use savings versus loans to pay for a child’s college education

There is an economic benefit to build and use savings versus loans to pay for a child’s college education

Financing College Education: Saving Versus Borrowing

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First, by saving early the parent ends up paying significantly less for college because of the interest earned while saving. Parents who save 17 years before their child enrolls at a four-year college at a 7 percent average annual return will end up saving only 58 percent of the total college cost (see Table 1).

Second, the parent who borrows will not only pay the full price of college but also the interest on the loan. Assuming a 7 percent average annual interest on the loan, the parent with a 10-year repayment plan would pay 139 percent more than the parent who saved. The parent with a 25-year repayment plan would pay 264 percent more than the parent who decided to save (see Table 2).

Third, the parent who services the loan is more restricted to investing money, thus experiencing an opportunity cost. If one takes the monthly payments of a 10-year repayment plan and of the 25-year repayment (see Table 2), and invests them instead at 7 percent compounded monthly, the parent with a 10-year repayment plan would forego $155,, and the parent with a 25-year repayment plan would forego $898, (see Table 3). Based on these calculations Louisiana payday loans Rayville LA, it is evident that saving for college is a better strategy than borrowing for college.

The purpose of this research is to investigate whether parents’ own student loan balances affect their decision to save for their child(ren)’s college education via tax-advantaged education saving vehicles and if they affect their decision to take out loans on behalf of their child(ren) for educational purposes.

Literature Review

A parent saving for their child’s college implies the parent has a plan for the future, and that he or she makes the child aware there are things needed to be done to attain higher education (Elliott 2009; Nam, Kim, Clancy, Zager, and Sherraden 2013). A parent can help finance the college education of their children by saving and/or taking out loans on behalf of their children-usually a Parent PLUS loan. When it comes to education saving, parents can use tax-advantaged vehicles such as the Coverdell education savings account (ESA) or the 529 plan. A student can finance their own college expenses through various methods such as grants, scholarships, work-study programs, and student loans.

Effect of student loans on earnings and net worth. Student loans may have negative consequences for individuals if not used properly. Students who graduate with student loan debt tend to have lower net earnings shortly after graduation in part because they are under pressure to pay off loans and accept the first paying job they’re offered (Gervais and Ziebarth 2019).

Rothstein and Rouse (2011) claimed that student loan debt may cause constraints to individuals such as preventing them from purchasing homes and/or preventing them from getting ) concluded that student loan debt can affect the short-run financial stability of households. Their analysis of 2007 to 2009 panel data from the Survey of Consumer Finances found that the median net worth for households who did not owe any loans in 2009 ($117,700) was higher than the median of households with outstanding student loan debt in that same year ($42,800).

Racial/ethnic gaps. Sometimes student loans can have negative consequences on students, even if the aim of student loans is to reduce the education inequalities among different racial/ethnical groups in society. For instance, Kim (2007) concluded that the increasing dependence of students on loans to finance their own education might contribute to the increase in the racial/ethnic gaps in obtaining a degree. By using a hierarchical linear model, Kim (2007) found that for blacks, the higher the loan amount, the lower the probability the borrower would complete a degree.

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