Planning to borrow for your kid's college? Time to clean up your credit

We all know college is expensive, but most families don't understand true costs until senior year. This is when parents realize their college savings plan, if they have one, won't be enough.

However, if you haven't watched your financial footprint over the years, you might not be well-positioned for optimal borrowing. Assessing your financial house before senior year helps you create a plan and may uncover cash to put aside. According to finance experts, many families don't look hard enough at ways to free up current cash flow for college. But if you anticipate borrowing due to income constraints, here's what finance experts say you need to know.

Students should always borrow first.

Before you borrow, your student should take available federal direct student loans (aka Stafford). These loans impose a limit of $31,000 over five years to protect undergraduate students from exorbitant debt burden. Student borrowing also protects parents. Your teen needn't borrow the whole amount, and later, you can even help pay off loans if retirement goals are on track.

Parents shouldn't overborrow.

If student loans don't go far enough - they often don't - parents can borrow, too. Typical parent borrowing includes taking a federal Parent PLUS loan, co-signing a private student loan, or tapping home equity. Top credit scores (usually 750 or higher) qualify borrowers for low interest rates, says Tim Hewitt, Pennsylvania-based senior financial adviser with Wiley Group. "That means thousands of dollars saved simply because you manage your credit well," he says. Families can also tap retirement accounts. But overborrowing or drawing down retirement funds can be dangerous.

Nannette Kamien, a college-focused financial adviser and owner of Inspiration Financial Planning, says loans are best used as a short-term solution for chunky bills if, for example, the college doesn't offer a payment plan. "Loans aren't meant to be the primary way to finance college, and parents should consider whether a loan payment is realistic if they're not able to free up income for college bills," she says. Many advisers prefer families avoid borrowing beyond student loans, and look at more affordable colleges instead.

Borrowing is a personal decision that requires thinking about current debt, job stability, your age, and number of kids. Assessing the whole picture is critical before taking loans for that first child, Hewitt says. No matter what college path, polishing your credit score will give you flexibility as you move deeper into college bills and second or third children.

Steps to repair credit.

For a good credit score and access to low interest rates, paying bills on time is key - and paying the required minimum is imperative, though paying more or in full is best, says Leah Ingram, author of a new book, The Complete Guide to Paying for College. Your "credit utilization" ratio also affects credit score. Poorly managed credit cards can do real damage.

To monitor credit history, finance experts advise ordering credit reports from all three credit reporting agencies - Experian, Equifax and TransUnion - to scour for late or unpaid bills and mistakes, which take time to fix or dispute. Initially, getting all three at once to compare them is best, says Rod Griffin, Experian's director of public education. You're entitled to a free report from each agency once a year (order at annualcreditreport.com). After that, reports cost $12.50, but free options exist. For Experian, the Experian app provides free credit reports and FICO scores and monitors credit. For TransUnion and Equifax, Credit Karma offers the same.

Credit reports include anything debt-related, though not every account is reported to all three agencies. These include mortgage loans, auto loans, credit cards, retail services' installment loans, and collection accounts (unpaid bills that go to collections). Rent payments may be reported. Utility, cellphone, and cable bills usually aren't.

Late payments remain on reports for seven years from the original delinquency date but may not be a big factor. "The further in the past a delinquency occurred, the less effect it has on your credit score," Griffin says. "But catching up on late payments helps your score recover more quickly even though the late payment stays on your report."

Credit reports don't include credit scores, but purchasing one score report (approximately $15) is a good idea, Griffin says. The report includes your credit score, "risk factors," and actionable steps to repair credit. Scores typically vary across the three agencies, but risk factors tend to be consistent, so ordering one score report is adequate, Griffin says. Then, for ongoing tracking, many credit cards offer free FICO scores.

Ingram recommends tackling credit cleanup starting in middle school to allow time for black marks to fall off by college. Repairing credit anytime benefits you.

Paying down consumer debt before college also helps, Kamien says, translating into available cash for college. Eliminating debt may also reduce available savings and could improve your financial aid picture. But don't drain savings accounts to qualify for aid. Even if your student qualifies, you'll likely have hefty college bills.

Several ways to borrow.

Federal Parent PLUS loans are quite accessible. They can sink you for the same reason. With a fixed interest rate of 7 percent, they help people with mediocre credit scores, and they offer protections, including graduated or extended repayment and dischargement if the parent or student dies. They also include a hefty 4.264 percent origination fee.

Parents with top FICO scores can get better interest rates with private student loans. Ingram's family qualified for 4 percent due to their 801 score. Keep in mind, although technically a student loan, parents typically must co-sign because students don't have qualifying credit history. That means parent credit is on the hook. It's hard to hang onto low interest rates. As Ingram's girls moved through college and she and her husband co-signed additional loans, their interest rates increased.

Taking a low-interest home equity line of credit (HELOC) might make more sense. A HELOC functions like a credit card in that you borrow only the amount you need as you go. Tying up too much money in college bills means it's not available for home emergencies. Financial advisers also get nervous about adverse events like a job loss. However, if used wisely, Hewitt says, borrowing against equity can be a good choice.

The key is to assess finances early, long before that first tuition bill. College is a huge expense, so consider consulting a fee-based financial adviser who understands college. Also, Ingram recommends, begin amassing money a year ahead of the bills, however you intend to pay. Borrowing desperately in August can set you up for financial heartache down the road.

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Nesbit writes about education, parenting and family travel. Find her work at www.joannanesbit.com or follow her on Twitter at @joannanesbit.