How to Get Alternative Student Loans

Four Methods:Borrowing against Real EstateBorrowing against Life Insurance PoliciesWithdrawing from Retirement AccountsBorrowing from Private Lenders

Student loan programs sponsored by the Federal Government often don’t cover the full costs of attendance for a student, forcing families to look for other ways to cover college costs. There are a variety of different ways to do so. For most borrowers, borrowing against real estate—via a second mortgage or a refinance—is the cheapest option, followed by borrowing against insurance, borrowing from retirement plans, and taking out a student loan with a private lender, in that order. By educating yourself about each type of option, you can make the best decision for you.

Method 1
Borrowing against Real Estate

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    Use a home equity loan to finance college costs. A home equity loan is a type of second mortgage, subject to the same type of process as a first mortgage. If you take out a home equity loan, you receive the money in one lump sum, and the length of the mortgage can be anywhere from 5-30 years.[1]
    • You can generally borrow anywhere from 80-90% of the equity in your home with a home equity loan.
    • Interest rates for home equity loans are usually fixed. The rates can be attractive, because your home is used as collateral.[2] Conversely, if you fall behind on your loan, you put your home at risk for foreclosure.
    • Since this is a second mortgage, you can expect to have another monthly payment to add in addition to your original mortgage.[3]
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    Access a home equity line of credit to finance college costs. A home equity line of credit, or HELOC, is another type of second mortgage. Since it is a second mortgage, it will be subject to the same types of conditions as a first mortgage, and the application process will be similar.
    • The difference between a HELOC and a home equity loan is twofold: HELOCs usually have variable interest rates, and the money isn’t given out as a lump sum, it’s a line of credit, like a credit card.[4][5]
    • HELOCs have a period of time for which you can access the funds, usually 10 years. Typically, the loan has to be paid off in its entirety in 20 years.
    • For the draw period, every time you make a payment, that amount of money becomes available for credit purposes.[6] For example, if the line of credit is $100, and the debtor uses $20, leaving $80 in the line of credit. When the debtor makes $20 in payments, then the line of credit goes back up to $100.
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    Obtain a cash-out refinance of your original mortgage agreement. A cash-out refinance is not a second mortgage, unlike a HELOC or home-equity loan. A cash-out refinance is a different mortgage that subsumes the original mortgage.[7]
    • The new mortgage is for a larger amount than the first mortgage, and the debtor receives the difference, hence the term “cash-out.”[8][9][10] So if the original mortgage is for $100 and the debtor gets a cash-out refinance, the new mortgage might be for $150, allowing the debtor to pocket the $50.
    • Since the new mortgage replaces the old, there is only one monthly payment, in contrast to the second mortgage options.
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    Pay attention to interest rates. With cash-out refinancing in particular, you can come out ahead or behind depending on what the current interest rates are. Getting your hands on the funds might still be worth the higher monthly payment, but it’s something to pay close attention to.

Method 2
Borrowing against Life Insurance Policies

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    Determine cash value. All permanent life insurance policies (anything that isn’t term life insurance) accumulate a cash value the longer you pay into it. If you’ve held onto the policy long enough, you can borrow against the accumulated cash value of the policy.[11][12]
    • When you first get a life insurance policy, premiums exclusively go towards the indemnity, which is the amount paid out in the event of death.[13]
    • Each insurer has different rules about how fast the policy accumulates cash value, how much can be borrowed against, and when the policyholder can borrow against it. Check with your insurer to find out the details of your own policy.
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    Determine interest. Compared to many types of loans, the interest on policy loans can be low, because the policy itself is used as collateral. However, the interest rate is only one factor to consider on a policy loan, and costs can arise elsewhere.[14][15]
    • This is subject to change depending on the insurer, the creditworthiness of the borrower, and the length of time the policyholder has had the policy.
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    Be sure to make payments or face major penalties. While policy loans can have attractive interest rates, the penalties for not paying sufficient amounts can be severe.[16]
    • Failing to make payments on a policy loan is going to make interest add up. Unpaid interest is added to the value of the loan, and if the value of the loan equals the amount you’ve paid on the policy, your insurer will surrender the policy.[17] So, if you have paid $100k on the policy and borrowed $70k, when the interest on the loan accrues enough to reach a value of $100k, your insurance company surrenders the policy and keeps what you paid into it, making a $30k loss for the policyholder.
    • The tax consequences can be severe. When you add taxes to the above scenario, things get ugly fast. For tax purposes, the 30K that you lost is treated as if it wasn’t lost. So in addition to the 30k loss, you have to pay taxes on the full tax out value of the policy, which is $100k in this case. That can easily mean thousands more in tax liability.

Method 3
Withdrawing from Retirement Accounts

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    Withdraw from your 401(k). You can withdraw money from your 401(k) for the purposes of paying higher education costs for yourself or your immediate family.
    • Education costs qualifies as a hardship withdrawal, but it is still subject to a 10% withdrawal penalty.[18]
    • There are no penalties for withdrawing money from a 401(k) for any reason if you are at least 59 ½ years of age.
    • No matter what, withdrawing money from a 401(k) counts as income, and it is subject to taxation.
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    Withdraw from a conventional IRA. For the purposes of paying for higher education, withdrawing money from an IRA is a better deal for the owner of the account than withdrawing from a 401(k). No penalties are assessed for higher education costs.[19]
    • Withdrawals still count as income, however. They will be taxed.
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    Withdraw from your Roth IRA. This can be an attractive option, because Roth IRAs are more flexible than other types of retirement accounts. There are fewer associated withdrawal penalties and withdrawals are always untaxed.
    • You can withdraw money that you have contributed to your account at any time, for any reason without paying taxes.[20]
    • If you are 59 ½ you can withdraw money for any reason that the account has earned after 5 years without tax or penalty. If you are under 59 ½ or the account is less than 5 years old, you may withdraw earnings for higher education without the 10% penalty, although you have to pay taxes. Non-qualified withdrawals are subject to a 10% withdrawal fee.[21]

Method 4
Borrowing from Private Lenders

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    Take steps to improve credit. Taking out a student loan from a private lender is probably the most expensive way to finance college education. Therefore, it is imperative that you take steps to improve your credit before you take out the loan, so that you can do everything you can to reduce your interest rate.
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    Make sure you have exhausted other options. Student loans are one of the only types of debts that cannot be discharged in bankruptcy, which means that they are an obligation that can follow you around in spite of major financial reversals.[22]
    • When the permanency of all student loans is combined with the near usurious interest rates charged by many private lenders, you need to make sure than you have exhausted all other options before you take out a private student loan.
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    Search for the best rates. Be very diligent in searching for a private student lender, as it can affect your financial future for years to come. There are a variety of websites that offer comparisons in rates for student loans, but https://www.credible.com/student-loans and http://www.simpletuition.com/ are both well-regarded.
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    Think about co-signing. If you are a parent, then consider co-signing on your child’s loan rather than taking one out in your name. Although you will be on the hook if things go south in either case, you might be able to limit your liability beforehand.[23]
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    Calculate the costs of attendance. All universities must issue information that documents the costs of attendance, and it's fine to use that. It is usually included with the financial aid award letter.
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    Gather the information for the application. You should gather information for the student and the borrower, if they are two different people, or the student and the cosigner, if there is one.[24] You will need:
    • School information, including school name, major, grade, and school term for which you need the loan
    • Social Security number
    • Telephone numbers
    • Current addresses, both for your home and your school
    • Gross income information
    • Residence information, including whether you own or rent, and the monthly housing payment
    • Requested loan amount
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    Allow at least three weeks to get the application approved. It's best to get on this as early as possible, right after you get your financial aid award. It can take nearly a month to get approved for a private loan, which could push back your enrollment.[25]

Sources and Citations

  1. http://www.bankrate.com/finance/home-equity/home-equity-loan-heloc-or-cash-out-refi.aspx
  2. https://www.usbank.com/home-loans/home-equity/home-equity-loan.aspx
  3. https://www.usbank.com/home-loans/home-equity/second-mortgage.aspx
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Article Info

Categories: Mortgages and Loans | Budgeting and Financial Aid for College