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 Saving money in advance and obtaining financial aid are common ways for parents to make their child's education affordable. Other ways of making college affordable, such as attending college part time, will be discussed later in this handbook. (See the section Are there other ways to keep the cost of college down?)
Saving Money Saving money is the primary way to prepare for the costs of college. Setting aside a certain amount every month or each payday will help build up a fund for college. If you and your child begin saving early, the amount you have to set aside each month will be smaller.
In order to set up a savings schedule, you'll need to think about where your child might attend college, how much that type of college might cost, and how much you can afford to save. Keep in mind that colleges of the same type have a range of costs and your child may be able to attend one that is less expensive. You can also pay part of the costs from your earnings while your child is attending school. In addition, your child may also be able to meet some of the costs of college by working during the school year or during the summer. Finally, some Federal, State, or other student financial aid may be available, including loans to you and to your child. You will also want to think about what kind of savings instrument to use or what kind of investment to make. By putting your money in some kind of savings instrument or investment, you can set aside small amounts of money regularly and the money will earn interest or dividends. Interest refers to the amount that your money earns when it is kept in a savings instrument. Dividends are payments of part of a company's earnings to people who hold stock in the company. A savings instrument has an "interest rate" associated with it; this refers to the rate at which the money in the instrument increases over a certain period of time. Principal refers to the face value or the amount of money you place in the savings instrument on which the interest is earned. Chart 7 shows how much you would need to save each month in order to have $10,000 available when your child begins college. As the chart demonstrates, the amount varies depending on the interest rate you obtain and the number of years that you save. The higher the interest rate and the earlier you begin to save, the less you need to set aside each month. For example, if you start saving when your child is born, you will have 18 years to save. As shown on the chart, each month you will only have to deposit $32 in an account earning 4 percent interest in order to save $10,099 by the time your child is 18. However, if you use the same savings instrument but do not start to save until your child is 16, you will have to save $401 each month. In addition, if you use the instrument with the higher interest rate -- 8 percent -- you will only have to put away $21 each month starting when your child is born. Remember, by starting to save early and by using instruments with higher interest rates, you can put aside smaller amounts. If you wait until later to start saving, you may not be able to afford to put away the larger amounts of money needed to meet your savings goals. CHART 7 Amount You Would Need To Save To Have $10,000 Available When Your Child Begins College Amount Available when Child Begins College
If you start | Number ------------------------------------------
saving when | of years | Monthly | | Interest | Total
your child is | of saving | savings | Principal | earned | savings
--------------|-----------|----------|-------------|------------|-----------
| (Assuming a 4 percent interest rate.) |
Newborn | 18 | $32 | $6,912 | $3,187 | $10,099
Age 4 | 14 | 45 | 7,560 | 2,552 | 10,112
Age 8 | 10 | 68 | 8,160 | 1,853 | 10,013
Age 12 | 6 | 124 | 8,928 | 1,144 | 10,072
Age 16 | 2 | 401 | 9,624 | 378 | 10,002
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(Assuming an 8 percent interest rate.)
Newborn | 18 | $21 | $4,536 | $5,546 | $10,082
Age 4 | 14 | 33 | 5,544 | 4,621 | 10,165
Age 8 | 10 | 55 | 6,660 | 3,462 | 10,062
Age 12 | 6 | 109 | 7,848 | 2,183 | 10,031
Age 16 | 2 | 386 | 9,264 | 746 | 10,010
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When deciding which type of savings instrument or investment is right for you and your family, you should consider four features: Risk: The danger that the money you set aside could be worth less in the future. Return: The amount of money you earn on the savings instrument or investment through interest or dividends. Liquidity: How quickly you can gain access to the money in the instrument or investment. Time Frame: The number of years you will need to save or invest. When you select one or more savings instruments or investments, you should balance these factors by minimizing the risk while maximizing the return on your money. You will also want to be sure that you will be able to access the money at the time you need to pay for your child's education. If you start early enough, you may feel confident about making some long-term investments. Some investments are riskier than others but can help you earn more money over time. Chart 8 lists some of the major kinds of savings instruments and investments that you may want to use. You can get more information on these and other savings instruments at local banks and at your neighborhood library. Don't forget that you won't necessarily have to save for the entire cost of college. The following section tells about student financial aid for which you and your child might qualify and other ways to keep college costs down. Chart 8 Examples of Savings Instruments and Investments SAVINGS INSTRUMENTS Savings Accounts Definition: Accounts at a bank, savings and loan, or credit union. Risk: Low risk because the Federal Government guarantees your money up to $100,000. Return: The interest rate on most savings accounts tends to be relatively low. Liquidity: High liquidity--you can withdraw your money at anytime. Time Frame: Good for shorter time periods--3 years or less. Certificates of Deposit (CDs) Definition: CDs are notes issued by banks that guarantee payment of a fixed interest rate until a future date (the maturity date). Risk: Low risk because CDs of $100,000 or less are insured by the Federal Govemment. Return: Interest rates are generally higher than the rates for savings accounts but lower than the rates for longer term or riskier investments. Liquidity: Relatively low--if you withdraw the money before the maturity date, you pay a financial penalty. Time Frame: Good for medium time frames--anywhere from 6 months to 5 years. Money Market Accounts/Money Market Mutual Funds Definition: Money market accounts are savings accounts offered by banks, requiring a high minimum balance. Money market mutual funds are available from brokers, many banks, and directly by mail. The money that you deposit in these funds is invested in a wide variety of savings instruments. Risk: Bank money market accounts have no risk on the first $100,000 because the government insures up to this amount. Money market mutual funds are not guaranteed by the government, but the bank or brokers usually invest the funds in very safe short-term instruments that have the highest credit ratings. Return: The interest rate for bank money market accounts is generally somewhat higher than for regular savings accounts. Rates on money market mutual funds are often somewhat higher than for bank money market accounts. Liquidity: High liquidity--you may withdraw your funds at any time. However, money market mutual funds do not have to send you a check for up to 3 days. Time Frame: Money market instruments are best for short-term savings goals. However, because of their great safety and liquidity, many people keep a portion of their total college savings in these types of accounts. U.S. Savings Bonds* Definition: U.S. (EE) savings bonds are promises by the U.S. Treasury to repay the owner with interest when the bond is redeemed. Bonds earn interest for as long as 30 years. Bonds earn market-based rates right from the start. They can be purchased from banks and through employer payroll deduction plans in amounts 24 as little as $50. Risk: Savings bonds are completely risk-free since they are Federal Government obligations. Return: The interest rate on a savings bond is usually higher than rates on savings accounts or money market mutual funds. However, if the bonds are cashed in (redeemed) before 5 years they may pay a lower rate of interest. Liquidity: Savings bonds are highly liquid and can be cashed in at any bank in the U.S., not just the bank where you bought them. Time Frame: Good for medium and longer term savings. Although they can be cashed in any time, the maximum interest is obtained by holding them longer. * If you buy Series EE bonds to pay for your child’s education, the money accumulated will be exempt from State and local taxes when you cash them in if the bonds are in the parent's name and if you are a single income tax filer and your income is below $42,300 or a joint filer and your joint income is below $63,450. The U.S. Treasury publishes a brochure about savings bonds -- see the address and phone number in the back of this handbook. INVESTMENTS Mutual Funds Definition: These funds can be invested in U.S. Government securities or in stocks and bonds. You can purchase a mutual fund through an investment firm, brokerage house, many banks or directly by mail. Risk: Risk varies widely depending on the objectives and policies of the fund. Funds are not federally insured, but your money is generally safer in a mutual fund than in a few individual common stocks because a mutual fund invests in many different stocks and bonds and thus spreads the risk over many different investments. Return: The return on a mutual fund depends on whether the fund makes good investments. Liquidity: Very liquid--you can sell the fund at any time. However, the amount of money you can get for the fund depends on its value, and the value changes regularly depending on conditions in the stock and bond markets. Time Frame: Good for longer term investing--5 years or more. Individual Corporate Bonds or Stocks Definition: A bond is a promise by a corporation to repay the face value of the bond, plus a fixed rate of interest, at a specific future date. Stock represents part ownership of a company. You make money on stocks either through the dividends you earn or by selling the stock at a price that is higher than the price for which you bought it. The prices of most stocks--and many bonds--are listed in major daily newspapers. Over longer periods, the price of the stock may increase or decrease. Stocks and bonds can be purchased from brokerage houses and through some banks. Risk: The stocks and bonds of good companies can be quite safe over longer time periods. However, these investments are not guaranteed by the Federal Government or anyone else. Furthermore, there are many companies that are very risky for a person to invest in. An additional risk--even for good companies--is that prices of their stocks will fluctuate widely and that an investor will have to sell at a loss. This is risky for a parent who may need to sell the stock to pay for college tuition at a time when the price of the stock is relatively low.
Return: Interest rates on bonds vary depending on the type of bond and its rating. Generally, returns are higher than on savings accounts, CDs and U.S. Savings Bonds. The return on individual stocks can be very high depending on the dividends the company pays and the increase in the price of the stock. However, returns can also be low or negative if the price of the stock falls between the time you bought the stock and the time you sell it. Liquidity: Most types of corporate and all types of government bonds are highly liquid. They can be sold through a broker on any weekday that markets are open. However, some bonds can only be sold when buyers make offers. Most individual stocks can be sold almost any day; however, there an some exceptions. With both stocks and bonds, you may have to wait for up to 3 days from the date of sale for the broker to send you the proceeds. Time Frame: Short-term bonds are good for time periods of 1-3 years. All other bonds and common stocks should be considered as longer term investments good for periods of 5-18 years. U.S. Treasury Securities (Treasury Bills, Notes, or Bonds) Definition: The Treasury Department and Federal agencies issue different types of fixed-income investments such a short-term bills (13-, 26-, 52-week bills), medium-term notes (2-10 years), and long-term bonds (over 10 years). These securities can be purchased directly from regional Federal Reserve banks, through regular banks, and through brokers. Because there are relatively large minimum purchase amounts some people prefer to invest instead in mutual funds that invest only in U.S. Government securities. Risk: These securities have no risk since they are backed by the Federal Government. Return: Interest rates on government securities vary with the maturity of the issue. As with other fixed-income investments, short-term issues generally have lower interest rates than longer term issues. All government securities have interest rates that are lower than corporate securities with the same maturity because the government securities are considered safer. Liquidity: Government securities are highly liquid and can be sold through brokers on any day the financial markets are open. Time Frame: Government securities have a wide variety of maturities and can, therefore, be tailored to any time frame needed by families saving for college. Financial Aid Financial aid can help many families meet college costs. Every year millions of students apply for and receive financial aid. In fact, almost one-half of all students who go on for more education after high school receive financial aid of some kind. In school year 1994-95, postsecondary students received about $47 billion in financial aid. There are three main types of financial assistance available to qualified students at the college level: 1. Grants and Scholarships
2. Loans
3.Work-Study
Grants and Scholarships Grants and scholarships provide aid that does not have to be repaid. However, some require that recipients maintain certain grade levels or take certain courses. Loans Loans are another type of financial aid and are available to both students and parents. Like a car loan or a mortgage for a house, an education loan must eventually be repaid. Often, payments do not begin until the student finishes school, and the interest rate on education loans is commonly lower than for other types of loans. For students with no established credit record, it is usually easier to get student loans than other kinds of loans. There are many different kinds of education loans. Before taking out any loan, be sure to ask the following kinds of questions: What are the exact provisions of the loan?
What is the interest rate?
Exactly how much has to be paid in interest?
What will the monthly payments be?
When will the monthly payments begin?
How long will the monthly payments last?
What happens if you miss one of the monthly payments?
Is there a grace period for paying back the loan?
In all cases, a loan taken to pay for a college education must be repaid, whether or not a student finishes school or gets a job after graduation. Failure to repay a student loan can ruin a person's credit rating and make finances much more difficult in the future. This is an important reason to consider a college's graduation and job placement rates when you help your child choose a school. Work-Study Programs Many students work during the summer and/or part time during the school year to help pay for college. Although many obtain jobs on their own, many colleges also offer work-study programs to their students. A work-study job is often part of a student's financial aid package. The jobs are usually on campus and the money earned is used to pay for tuition or other college charges. The types of financial aid discussed above can be merit-based, need-based, or a combination of merit-based and need-based. Merit-based Financial Aid Merit-based assistance, usually in the form of scholarships or grants, is given to students who meet requirements not related to financial needs. For example, a merit scholarship may be given to a student who has done well in high school or one who displays artistic or athletic talent. Most merit-based aid is awarded on the basis of academic performance or potential. Need-based Financial Aid Need-based means that the amount of aid a student can receive depends on the cost of the college and on his or her family's ability to pay these costs. Most financial aid is need-based and is available to qualified students. |
