It may be better for students to borrow during college and save 529 plan funds for graduate school.

Consider Student Loan Interest Rates to Maximize College Savings

How student loan interest will accrue during college should be a factor in plans to use 529 savings.

It may be better for students to borrow during college and save 529 plan funds for graduate school.
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Families with students in college experienced a student loan interest rate hike scare earlier this year. Congress took action this summer to keep rates on subsidized Stafford loans from rising from 3.4 percent to 6.8 percent, but that doesn't mean rates won't rise in the future. 

Families who plan to pay for college with both student loans and money in 529 college savings plans should consider the following as they evaluate how to balance borrowing with savings from these tax-advantaged investment accounts. 

1. Plans for graduate school: If a student is planning on attending graduate school, it's best to borrow in undergraduate years, says Jerry Love, a Texas-based certified public accountant. 

"I advise families to borrow earlier, rather than later," he says. 

Even if federal student loan interest rates rise, interest rates on federal loans for graduate school will always be higher. For the 2013-2014 school year, both subsidized and unsubsidized federal student loans for undergraduates have a fixed interest rate of 3.86 percent, while graduate students are charged a minimum of 5.41 percent and only have unsubsidized options, regardless of financial need. 

[Find out how to allocate college savings for graduate school.] 

2. Amount actually needed for school: Avoid banking money from student loans for later use, says Jim Brooks, financial aid director at the University of Oregon

While student loan interest rates are low right now, it's never a good idea for students to borrow more than they need for that particular semester for tuition, textbooks and other educational expenses. Students will likely spend the money rather than saving it, he says. 

But that doesn't mean families can't allocate college savings for later years of college if doing so is part of an overall college budget. Experts say that if a student qualifies for subsidized student loans, these loans should be borrowed up to the amount needed. That's especially true for students planning on going to grad school, where subsidized federal student loans aren't an option. 

[Know what 529 plan savings can pay for.] 

3. Interest accruing during school: When debating whether to use student loans to pay for early or later undergraduate years, remember interest will still accrue on unsubsidized student loans, says Brooks. 

Thus, families should consider if their investment returns will offset interest rate charges, says Jason Washo, a certified public accountant and personal financial specialist in Arizona. 

As low as interest rates are, investments may not be earning as much interest because of the current overall low interest rate market, he says. Families should have their financial advisor help them calculate the difference between interest charged on what they'd earn and what they'd pay, especially because borrowing early means interest on student loans will accrue for a longer period of time. 

However, Washo says the best decision may be to use equal amounts of borrowing and college savings throughout college. Since the future is unknown, he says, this a conservative approach that makes sense no matter what happens to interest rates. 

[Take these steps to use 529 plan funds for college.] 

4. Potential interest rate changes: Interest rates have been low for quite a long time. However, it's impossible to predict what the future holds at this moment, says Love. Families shouldn't make decisions based on potential rises in the interest rate market, he says. 

Student loan interest rates depend both on Congressional action and the economic environment. But what is predictable is that tuition will increase. 

According to the College Board's "Trends in College Pricing 2012" report, tuition prices were nearly 5 percent higher for in-state students at public four-year universities in the 2012-2013 school year versus the 2011-2012 school year. Families should stash away as much savings as possible for a college education, experts advise. 

Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.