A personal loan shouldn’t be your first choice for college funding, but it still might be an option. Technically, you can apply funds from a personal loan to pay for just about anything, and it might be a good way to cover some college-related costs. Here is a look at why other options are likely a better choice.
What Is a Personal Loan?
A personal loan is a term loan, usually without collateral. When you take out a personal loan, you typically receive a lump sum of money from about $1,000 to $100,000 and pay it back in installments over one to seven years.
[Read: Best Personal Loans.]
What Can Personal Loans Be Used For?
There are many personal loan uses, ranging from home repairs and renovations, to consolidating high-interest debt, or financing a vacation or even a wedding.
Generally, a personal loan is designed for you to use the money at your discretion, says Rod Griffin, senior director of public education and advocacy for credit bureau Experian. “If it meets the lender’s criteria and there are no restrictions toward that end, you certainly could use a personal loan to pay tuition and other college costs,” Griffin says. “The question is whether it’s the right tool for the job.”
To use a personal loan to pay for college, you would need to check with a lender first — many have specific restrictions against using personal loan funds for postsecondary education.
Also, it’s unlikely that a college student would have enough income, assets and credit history to qualify for a personal loan on his or her own, and likely would need a parent to co-sign.
Is a Personal Loan Better Than a Student Loan?
If you’re using a personal loan to pay for college, you should first consider how it stacks up against your student loan options.
“As with any debt you’re going to take on, you need to see what the terms are and compare it with other vehicles that might be better,” Griffin says.
Federal or private student loans are better borrowing options for college students, as these loans are expressly designed for people trying to pay for higher education.
[Read: Best Private Student Loans.]
Federal student loans are usually the most affordable way to borrow, with no credit check, low fixed interest rates, and potential eligibility for federal relief programs, forbearance and income-driven repayment plans.
“You don’t always have those options with other kinds of loan products,” Griffin says.
Private student loans are also an option, but their interest rates are often higher than federal loans and interest will accrue during college.
With student loans, repayment typically begins after you leave school and can stretch for as long as 20 to 25 years — much longer than typical personal loan installment plans. That could be a problem if you want to clear your debt quickly, but you might find it’s advantageous to have a longer loan term, which typically translates into lower monthly payments over the life of the loan.
As students pay off student loan debt, they can take a tax deduction of up to $2,500 per year. There are no tax deductions for personal loan payments.
But personal loans can have some advantages over student loans. For example, student loans can be difficult if not impossible to discharge in bankruptcy. Also, you can’t refinance federal student loans through the U.S. Department of Education, although you can consolidate them into one payment or get private student loan refinancing.
Graduate students who have a high enough income, strong credit record and the ability to pay back a loan right away might consider personal loans, says Marcio Silveira, associate financial advisor for Toler Financial Group in Maryland.
For example, he says he knows international students who were not able to get student loans but secured personal loans from banks that allowed them to pursue MBAs.
However, there are federal and private student loan options specific to graduate students that might be a better deal.
Should a Parent Use a Personal Loan?
Parents often help pay for their children’s college education and might consider a personal loan to cover part of the cost.
If your student is in the first or second year of college, taking out a personal loan to fill a college-related funding gap every year can cause an unmanageable debt load. However, it might work in other situations.
“A personal loan could make a lot of sense if the interest rate is right, and the term is agreeable for filling a gap,” Griffin says. “If a student is in the last semester, everything else has been paid for and you’re short $2,000, a personal loan could be ideal.”
Other options for parents could include:
Federally backed loan. The Parent PLUS Loan has a higher interest rate than most federal student loans but has lenient credit qualifications and longer repayment periods than typical loan products.
Home equity loan or home equity line of credit. Increases in home values and low interest rates make both of these attractive options, but you need to be prepared if there is a decline in home values, Griffin says. If that happens, you could find that your home value falls so low, it leaves you underwater, with equity debt levels higher than the value of your home, which happened to many homeowners in 2008 and 2009.
[Read: Best Home Equity Loans.]
“I’m always cautious about using my house as a security for a loan,” Griffin says.
IRA or 401(k) withdrawals. It is possible to tap both your 401(k) and individual retirement account to pay for college expenses. But both have drawbacks — you’ll likely pay income tax on the money you take out, and 401(k) withdrawals may have an additional 10% penalty.
Also, you’ll make it that much tougher to save enough money for retirement.
“You can definitely finance college education, but you cannot finance retirement,” Silveira says.
Other Financing Options to Consider
When you’re facing a college funding gap, there are options in addition to lender-provided loan products and federal student loans, such as:
School financial aid. If your family has had a significant change in financial status, it’s possible a school might take that into consideration and provide more aid. Colleges are fielding more appeal requests during the coronavirus pandemic.
Some schools offer payment plans, likely through a third party at no interest and with a small enrollment fee. You could make payments for a semester over several months or more.
“It’s always advisable to talk to financial aid offices at schools because they can provide a lot of options,” Griffin says.
Family loans. A loan from a parent or another relative to a student could be ideal to fill a gap in financing, although all parties need to be careful of the potential pitfalls.
There needs to be strong communication and a written agreement, as well as realistic expectations on when the money will be paid back.
“If there is trust and history of honoring commitments within the family, personal loans from a family member can go a long way,” Silveira says. “It can benefit all the parties — a better rate of return for the lender, better terms for the borrower.”
There are many expenses associated with a college education — from tuition and room and board, to books, travel and other personal expenses. All require smart financial planning to ensure the costs don’t overwhelm a family.
“When you’re looking at college costs, they all fall into the same equation,” Griffin says. “If you’re paying for a piece of it with a personal loan, it might or might not make sense based on your personal needs. Credit is so dependent on an individual situation.
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