Saving for Your Kid's College? There's an Alternative

The summer before freshman year of college, most students are filled with excitement as they prepare to embark on an adventure that will change their lives. However, their excitement is often overshadowed by concern for the high cost of education. They are aware of the burden that comes with debt even if they don’t know the onerous statistics. Today there are over 44 million student loan borrowers who have accumulated approximately $1.3 trillion in debt, and on average, each one of those borrowers will be faced with repaying a loan of $37,172.

It is a daunting experience for young folks to commit to a loan for a large sum in exchange for a college education. However, for most it is necessity. In fact, up until this point in life, most students have never even contemplated a loan, much less one with five digits. (For more, see: Hot Employee Benefit: Student Loan Repayment.)

Fast forward four years as college ends and students prepare to enter the professional workforce. While they are looking forward to the next chapter of life, their excitement is tempered by worry over how to repay loans as they are struggling to get established in the work world. 

Fast forward another 15 years to a time when students are liberated from loan debt and are providing for families of their own. With the rising costs of college, how are they going to pay for their children to attend? Based on their own experience, they don’t want their kids to be saddled with mountains of debt like they had, so they need a better solution.

Many parents meet with financial planners to get advice, and many financial planners suggest a 529 plan, a post-tax savings plan that grows tax free. When a child hits college age, parents can use the money to fund expenses.

While this plan seems logical, there are issues with it. A 529 plan grows at a rate of about 4%. So, if parents were to save $5,000 per year per child (which is extremely tough to do), their child’s individual 529 plan would total about $160,000 when the child reaches age 18.

The 529 plan is problematic in that it assumes you save $5,000 per year per child for a full 18 years, which is nearly impossible for most parents. And if they do accomplish this monumental task of saving, $160,000 per child will not be enough to pay for many universities, let alone in 10+ years’ time when the child is ready to start college.

Moreover, 529 plans lack flexibility in some areas. For instance, what happens to your 529 savings if your child gets a full scholarship? Or what if your child decides to drop out of college to start a business after only one year of school? In other words, a 529 plan isn’t a one-size-fits-all solution for college savings. (For more from this author, see: 8 Questions to Ask Before Managing Rental Properties.)

After considering financing options with less-than-ideal outcomes, how should parents (or grandparents) prepare to finance college education? One highly effective and oft-overlooked option is real estate - that is, rentals on 15-year mortgages. Allow me to explain with an actual example.

A three-bedroom house purchased in Aurora, Colorado on January 2016 at $240,000 would result in a monthly mortgage (PITI) of $1,575 on a 15-year note. Renting out the property would bring in approximately $1,725 each month. Initially, $150 per month in positive cash flow seems lackluster, and when factoring in expenses, vacancies, fixes, etc., it’s barely a break-even proposition.  

But, and this is a big but, that house will be paid off in 15 years. Therefore, if new parents bought this home and rented it out for the next 18 years until their child starts college, their fund will have been paid off for three full years. At this point, the parents could choose to sell, refinance, or continue to use the positive cash flow from rent income, providing them with many terrific options.

The tangible benefits of this approach work not only for financing college but for other important life events: retirement, extra income, wealth and nest building, flexibility to take time off from work, and generational wealth creation for family, kids or grandkids.

Finally, one other oft-overlooked benefit of this approach: time will always be on your side. (For more from this author, see: Seasons Impact Real Estate More Than You Think.)

Ryan Boykin is co-founder of Atlas Real Estate Group, a Denver-based full-service realty firm.