Latest / The College Savings Podcast with Fexingo: 529 Plans, Education Funding, and Student Costs / How Student Loan Interest Rates Changed College Savings
Transcript
- Lucas: The number that is keeping parents up at night right now is not just the total cost of tuition, but the interest rate attached to borrowing it. In October of twenty twenty six, the federal government finalized a shift that pushes direct unsubsidized loan rates past ten percent for the first time in decades. That changes the math on every single college savings decision we have discussed previously. Luna: It feels like we are moving from a game of accumulating assets to a game of avoiding liabilities. If you borrow one hundred thousand dollars at twelve percent, the interest alone swallows half of the principal before graduation. Lucas: Exactly. And what makes this particularly sharp for our listeners is that this is happening alongside wage stagnation for entry level graduates. You are seeing the cost of the degree rise while the return on investment shrinks. We need to talk about how this forces a hard choice between saving for retirement and saving for education. Luna: Right, because the old advice was always prioritize your own retirement first. But when the penalty for not paying upfront becomes this severe, does that rule still hold water? Lucas: That is the central tension. Let us look at the mechanics. A typical four year degree now costs around eighty thousand dollars in today dollars if you include room and board. If a family borrows the full amount at ten point five percent fixed, the monthly payment post-graduation jumps significantly compared to the low single digit rates we saw just three years ago. Luna: I ran some numbers last week with a client who had two kids starting college within eighteen months. The projected debt service was eating nearly forty percent of their starting salary. Lucas: That is the trap. And this brings me to the specific angle I want to drill into today: the opportunity cost of liquidity. When you put money into a five hundred twenty nine plan, it is accessible, but pulling it out early might trigger taxes or penalties if not done carefully. However, keeping cash in a checking account earns nothing while the loan interest compounds aggressively. Luna: So the argument is that illiquidity is actually a feature here, not a bug. It forces discipline against the temptation to spend that college fund on something else. Lucas: Precisely. Now, before we get too deep into the portfolio allocation strategies, I want to take a quick moment to address how this show operates. We deliberately do not run ads on these conversations. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. It helps keep the research rigorous without corporate influence. Luna: Yeah, and having that independence means we can say things like this without worrying about a sponsor telling us to soften the blow on high interest rates. Lucas: Back to the strategy. The most common mistake families make in this environment is trying to time the market with short term cash reserves. They think they will save up over two years and then pay cash. But tuition inflation runs at about six to eight percent annually, outpacing general inflation. Luna: So waiting is expensive. Every year you delay funding the five hundred twenty nine, you are fighting a rising tide of costs plus a rising tide of loan rates. Lucas: Correct. Let us look at a concrete example. Say you have a child entering high school. If you invest fifteen hundred dollars a month in a balanced five hundred twenty nine portfolio, historical averages suggest you could cover a significant portion of public university costs by the time they graduate. The key variable is the internal rate of return of that portfolio versus the loan rate. Luna: If the portfolio grows at seven percent and the loan charges ten percent, you are losing ground even if the portfolio is green. Lucas: You are losing ground rapidly. This is why we are seeing a shift toward more conservative allocations earlier in the timeline. Ten years out, you might be comfortable with equities. Five years out, with loan rates this high, the risk of a market correction right before withdrawal becomes catastrophic. You cannot afford to wait for a rebound if you have tuition due in January. Luna: It forces a change in asset allocation that many financial advisors are slow to implement. They stick to generic glide paths instead of adjusting for the liability side of the balance sheet. Lucas: And that brings us to the second major point: the role of scholarships and grants as a hedge. Many families ignore merit aid because they assume their income is too high. But with private loans at double digits, every dollar of scholarship is worth more than a dollar of savings. Luna: Absolutely. Applying for those niche scholarships can feel like a part time job, but the return on investment is immediate and guaranteed. No market risk involved. Lucas: Right. So the new framework is not just 'save for college.' It is 'minimize borrowing at all costs.' That means maximizing grant eligibility, considering community college for the first two years, and treating five hundred twenty nine contributions as a priority over discretionary spending. Luna: It also means rethinking the value proposition of certain degrees. If the expected salary in an art history program does not clear fifty thousand a year, taking on ten thousand dollars in annual interest is a terrible deal. Lucas: That is a tough conversation for parents to have. But it is necessary. We are seeing students defer enrollment or take gap years to work and save specifically because the financing terms have become so hostile. It is a behavioral shift driven by cold hard economics. Luna: I wonder if this will push more families toward homeschooling or alternative certifications that don't carry the same debt burden. The credentialing system is under pressure. Lucas: It certainly is. But for those committed to the traditional path, the five hundred twenty nine plan remains the best vehicle, provided you manage the risk profile correctly. The tax-free growth is irreplaceable when you compare it to taxable brokerage accounts where capital gains taxes eat into your ability to cover the shortfall. Luna: And let us not forget the state tax deductions. Many states offer immediate tax breaks for contributions, which effectively gives you a free five to eight percent boost on day one. Lucas: That is the low hanging fruit. If you live in a state with a deduction and you are not taking it, you are literally throwing money away. Combined with the compounding effect of avoiding high interest debt, the synergy is powerful. Luna: So the advice is simple but hard to execute: start early, stay invested but adjust for proximity to enrollment, and treat every scholarship dollar as gold. Lucas: Yes. And one final nuance. Some parents worry that having assets in a five hundred twenty nine plan will hurt financial aid eligibility. But the rules for federal aid calculations actually favor student owned assets less than parent owned ones. Since five hundred twenty nine plans are usually in the parent's name, they are protected better than you might think. Luna: That is a huge relief. I have heard so many stories of families freezing their savings because they were scared of the aid formula. This data suggests they should be doing the opposite. Lucas: Exactly. Freeze your assets, lose the benefit. Contribute strategically, gain the protection. The landscape has changed enough that passive saving is no longer sufficient. You have to be active in managing the liability side. Luna: It really highlights how interconnected personal finance is with macro policy. The decisions made in Washington directly impact the bedtime routines of parents across the country. Lucas: They do. And as we move through the rest of twenty twenty six, keep watching the Federal Reserve's stance on long term rates. If they stabilize, we might see a slight reprieve, but the decade of ultra-low borrowing costs is likely over. Luna: So preparation is the only defense. Whether it is through aggressive saving, strategic schooling choices, or maximizing every available credit. Lucas: Preparation and discipline. It is never been more important to align your savings goals with the real cost of capital. If you are just starting this journey, the best time to open that account was yesterday. The next best time is this week. Luna: Agreed. Because unlike the stock market, you cannot short sell your child's education. You have to be long on their future, and that requires planning today. Lucas: Let us leave listeners with this question: when you look at your current savings rate, are you covering the tuition, or are you merely hoping to avoid the worst of the debt? The distinction matters more now than it has in thirty years.