Why Saving for College is Cheaper Than Borrowing

Why Saving for College is Cheaper Than Borrowing

| Posted in: College

Are you a new parent concerned about financing your child’s college education? Compare the cost of saving for college starting now versus not saving and having to pay for college with student loans.

By Janet Stanton Burt

Need some motivation to start saving for college while your children are young? Try this: If you don’t save and you have to use student loans to cover college costs, you could pay more than twice as much for the same education.

Mathematically, it makes sense that it’s less expensive to save when kids are young than borrow when they’re college-age. Thanks to the power of compounding (when your returns are reinvested and earn more returns), yesterday’s dollars saved can grow to be worth more than the original dollars you invested.

Meanwhile, student loan interest payments mean a dollar borrowed tomorrow always costs more than a dollar saved yesterday, or a dollar in hand today.

If you do find yourself short of assets to pay for college, there are less expensive options than student loans. Your child could work part time, defer for a year while earning money or start at a low-cost community college. You might ask relatives and close friends to contribute to college costs in lieu of other gifts.

Don’t Pay Twice as Much

How does borrowing versus saving for college end up costing twice as much?

Let’s say you start saving when your child is born, putting away $100 each month for 18 years. By the time your child is ready to start college, you will have deposited $21,600 in your education fund.

Assuming a 7.5% rate of return, your investments will have earned another $24,144 over the 18 years, according to the Saving vs. Borrowing calculator at FinAid, giving your child a total of $45,744 to help pay for college. That’s more than twice what you actually invested.                         

Now let’s see how much it would cost to borrow that same $45,744 to pay for college. 

Assuming an interest rate on the student loan of 6.8% (the 2015-16 Federal Direct PLUS Loan rate) and a standard repayment term of 10 years, you would end up repaying a total of $63,179, including $17,429 in interest.                                                                                                        

In our scenarios, relying on student loans means you’ll pay more than $40,000 extra to get the same education than if you’d begun saving when your child was born.

 

It’s Never Too Late

Even if your child is already in kindergarten or old enough to wear braces, it’s not too late to start saving for college. Your investments won’t have time to grow as dramatically as if you’d gotten an earlier start, but every dollar you’re able to save is a dollar you won’t need to borrow.

We’ve only got one caveat: Even though your parental instincts tell you to put your kids first, you should prioritize saving for your own retirement.

Your child will have several options beyond savings to fund her education, like grants, scholarships and, as a last resort, loans. You won’t have the same choices to fund your golden years.

We strongly suggest you create a goal and get your retirement saving on track before diverting money toward college investments.

Ready to calculate what you’ll need to save for college? Goal Investor can help you get a clear savings plan together that works with your budget.

The example above is for illustration only and is not meant to represent actual results. Investments involve risk and there is no guarantee that you will not lose money.  

This information is provided for education purposes only and is not intended to provide investment or legal advice. SEI does not claim responsibility for the accuracy or reliability of the information provided. 

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