For many consumer items, especially homes, interest rates remain near historic lows. But for new borrowers of college education loans, who number about 12 million each year, the steady uptick of rates is reason to consider updating your financial strategy.
On July 1, rates on federal student loans rose to 4.6 percent, up from last year's 3.86 percent. While that increase will only add about a $138 per year in repayment fees to a typical borrower (rates are locked in for all but new borrowers) it still adds to what has become a mountain of debt for students who need to finance their education. When new graduates collect their diploma and enter the job market that debt can take away from money that could otherwise be invested in important early career wealth-building activities, such as purchasing a home, starting an Individual Retirement Account, or buying a car.
These days about 70 percent of college students take out loans. A typical college graduate leaves school with $25,000 to $30,000 of debt while countless other graduates of law school, business school or medical school rack up bills of $100,000 and higher. Nationally, collective student debt exceeds $1 trillion.
While college loan rates remain a pretty good deal for consumers, minimizing the amount of money you borrow is the best way to avoid a whopping tab when you finish school. One of the most effective savings vehicles is known as a 529 plan. A 529 is an IRA-like education investment account that allows consumers to invest in mutual funds, withdrawing the money later to cover tuition, books and other educational fees. Gains in 529 accounts are tax deferred when used to pay for college education and upon withdrawal they avoid federal taxes entirely. 529s are also easy to manage -- you pick a mutual fund (index funds pegged to market performance are a common choice), make regular contributions of any size you wish, and let the money accumulate.
529s are also open to anyone without income restrictions and contribution caps are as high as $300,000 in some states. For two parents who file jointly, there is an annual $28,000 limit on how much money they can put into a 529 for a college-bound child.
In this fast-moving world the value of a college education has never been higher. Most observers would agree that entry into the job market and adopting new skills become much more difficult without the foundation of higher ed. But building financial security also depends on wise use of credit and on building assets from as early an age as possible. Using tools such as 529 accounts to offset the expense of college education is a smart way to fund higher education and to get a leg up on savings.