College or Mortgage?

[RayJay]

Everyone,

Opinion's please, I have a friend who has an extra $200 a month to apply to Mortgage? I told him College fund is what I would do. He has 3 kids, enough put aside for 1 kid, but he wants to pay down the house, then he can take Home Equity if he needs it, I said that sounds backwards.

Anyway I know this has been debated before, what do you all think?

RayJay

 

[runwad]

Everyone has different opinions on this but here's mine. I'd put it towards the college fund. And I don't think I'd risk my house for my kids college either with a home equity loan. I too have 3 kids and am pretty much just getting started saving for them 11, 9,6. I figure I'll save as much as I can and they'll have to get part time jobs and hopefully some scholarships..but I'm really not one to get loans for too much of anything. My house will be paid off 2 years after the oldest starts college just in time for #2 and #3 kid to start going

 

[ducklite]

I think if you do the math you would be better off putting it towards the mortgage. You'll save more in interest than you'd gain in interest in the college fund.

There's no guarantee that the kids will even go to college--they could opt for the military for example. They might get full scholarships. They might choose to go to a less expensive state school.

Takeing a HELOC to help pay for college will be no different than putting the money in a college fund.

Depending on the size of the mortgage and age of the kids and the term of the mortgage, an extra $200 a month might actually have it pretty close to paid off by the time the second is ready to start.

Anne

 

[shelly3girls]

Everyone's situation is different but I would either pay down the mortgage or put the extra $$ in a retirement account. Several things go into the equation for financial aid so if this family may qualify then they should speak with someone concerning the implications of how they save the money. Money magazine had an article last year about financial aid that implied that you were better off having money in retirement that does not count against you. College savings accounts count "against" you and mortgage payments act in your favor (of course the interest cost of this may not make it worth it).

 

[disneysteve]

You'll save more in interest than you'd gain in interest in the college fund.

How do you figure that? My mortgage is at 5.875%. After taxes, that's about 4.4% real interest rate. I can certainly invest my money and earn way more than that.

shelly makes a good point about qualifying for financial aid. I'm not sure how that works. Unfortunately, we probably won't qualify no matter what we do or where we put our money, so I'm not all that concerned about that aspect of things.

In general, I just think prepaying the mortgage is rarely the best investment option.

 

[shelly3girls]

How do you figure that? My mortgage is at 5.875%. After taxes, that's about 4.4% real interest rate. I can certainly invest my money and earn way more than that.

shelly makes a good point about qualifying for financial aid. I'm not sure how that works. Unfortunately, we probably won't qualify no matter what we do or where we put our money, so I'm not all that concerned about that aspect of things.

In general, I just think prepaying the mortgage is rarely the best investment option.

Steve,
I am going to look for that article. I think it is slim to none that we will qualify for financial aid but it was very interesting. Depending on the formula the school uses the article claimed that some families making up to $300k (I think, it was a year ago ) but had padded retirement accounts instead of college funds and had good size mortgages still qualified. I think it is the kind of article you would find interesting.

 

[TigerMouse]

How's your friend's retirement savings? He might be better off putting the $200/month towards a Roth IRA, which he could then use to pay for college (after 5 years) if needed - and which does not count against them in financial aid calculations.

 

[dcfromva]

Everyone,

Opinion's please, I have a friend who has an extra $200 a month to apply to Mortgage? I told him College fund is what I would do. He has 3 kids, enough put aside for 1 kid, but he wants to pay down the house, then he can take Home Equity if he needs it, I said that sounds backwards.

Anyway I know this has been debated before, what do you all think?

RayJay

There are several pieces to this puzzle which are unknown and would impact the decision.

First of all, is the interest rate on the mortgage a low fixed rate interest rate? If so, it would make no sense to pay down the mortgage with the idea of taking a loan out in future at possibly a much higher rate.

What type of education is the fella planning to provide for his kids? Is there are pre-paid tuition plan available? Some folks plan to pay for 4 year in state tuition for their kids (if the children elect to go elsewhere, it is up to them to come up with the difference). In this scenario, one could invest in a guaranteed pre-paid tuition plan (if it is availabe), the investment becomes inflation proof. By paying the money upfront, it could result in a huge discount over what would have to be paid later on with mortgage loans.


DC

 

[ducklite]

How do you figure that? My mortgage is at 5.875%. After taxes, that's about 4.4% real interest rate. I can certainly invest my money and earn way more than that.

shelly makes a good point about qualifying for financial aid. I'm not sure how that works. Unfortunately, we probably won't qualify no matter what we do or where we put our money, so I'm not all that concerned about that aspect of things.

In general, I just think prepaying the mortgage is rarely the best investment option.

It depends on the interest rate on the mortgage and the type of investment.

Like I said, the kids might not even go to college.

I do like the idea of a ROTH IRA that another poster brought up.

Anne

 

[bellarella]

I think if you do the math you would be better off putting it towards the mortgage. You'll save more in interest than you'd gain in interest in the college fund.

That's rare these days. I would say a majority of people who have owned a home for more than 5 years refinanced with interest rates below 6% --- some well below. Someone who has an extra $200 a month and is thinking of these sorts of things is exactly the type of individual who probably maximizes their financial opportunities, so probably has a lower interest mortgage.

There's no guarantee that the kids will even go to college--they could opt for the military for example. They might get full scholarships. They might choose to go to a less expensive state school.

If they get full scholarships you can "get out" of a 529 plan. If they don't attend you can change the beneficiary. With 3 kids, it's unlikely the money would go unused. Children from families that promote college education from a young age rarely don't go. Yes, it happens, but with 3 kids I would say that is a very low risk that you would be faced with an unqualified withdrawal.

Takeing a HELOC to help pay for college will be no different than putting the money in a college fund.

Actually it's very much different. There is no way of knowing now what interest rates will be when the children go to school or what their financial state will be when that time comes. Come college they could be facing double digit HELOC rates. With interest rates at near historic lows, the most likely scenario is that they will have to pay significantly more to borrow back their own money in the future than they would have saved in the present. Further, there is no guarantee that they will be allowed to borrow back that money. Stuff happens and if they are in a difficult financial position when the kids go to school they could be seen as bad risks and only qualify for sub-prime rates, if at all.

If, on the other hand, they put the money into savings, they keep the mortgage rate they have right now, which is probably as low as they will ever see, keep the money somewhat liquid and accessible, and will have more options in the future.

I agree with DisneySteve, that paying down a mortgage early is rarely a good idea if you have other savings goals not yet met.

 

[mickeyfan2]

I would put the $200 each month in their retirement account. Split the exising college fund three ways and the kids make up the rest.

 

[WeRblam]

Everyone's situation is different but I would either pay down the mortgage or put the extra $$ in a retirement account. Several things go into the equation for financial aid so if this family may qualify then they should speak with someone concerning the implications of how they save the money. Money magazine had an article last year about financial aid that implied that you were better off having money in retirement that does not count against you. College savings accounts count "against" you and mortgage payments act in your favor (of course the interest cost of this may not make it worth it).

My hubby is a CPA and always advises that you put your money in your retirement fund first. Second, pay down the mortgate - you always build equity. There are always low cost loans available if needed...

 

[Minnie824]

If putting the extra money towards the mortgage would help get the house paid off before the kids start college, then whatever (in addition to the $200) is paid monthly to the mortgage, once the house is paid, can go directly to pay for college. It may not be saved money, but its money that was always being spent on the house, now will be spent to college. That makes sense to me.

 

[disneysteve]

Like I said, the kids might not even go to college.

I do like the idea of a ROTH IRA that another poster brought up.

If the kids don't go to college, that's no problem at all if you keep the money in a regular taxable account rather than a 529. You can still far outperform the savings from prepaying a typical mortgage (as I illustrated above) and the money isn't locked into being used for college only.

As for the Roth idea, people often suggest this but I don't support that either. Roths are for retirement. I consider retirement savings to be sacred, not to be touched for anything other than retirement (except something truly catastrophic). If I raid my Roth to pay for DD's college, that money won't be there for me when I retire. Just not a good idea IMO.

 

[ducklite]

If putting the extra money towards the mortgage would help get the house paid off before the kids start college, then whatever (in addition to the $200) is paid monthly to the mortgage, once the house is paid, can go directly to pay for college. It may not be saved money, but its money that was always being spent on the house, now will be spent to college. That makes sense to me.

That was my train of thought, you explained it better. A former co-worker didn't save anything for his kids education. Instead he put it all into the mrotgage. He paid off the mortgage the year before his firstborn began college. He then used the "mortgage money" to help fund college for each of his four children. There was no borrowing by him, he had about $24,000 a year that he had previously put towards the mortgage to then use towards education costs.

Anne

 

[ducklite]

If the kids don't go to college, that's no problem at all if you keep the money in a regular taxable account rather than a 529. You can still far outperform the savings from prepaying a typical mortgage (as I illustrated above) and the money isn't locked into being used for college only.

As for the Roth idea, people often suggest this but I don't support that either. Roths are for retirement. I consider retirement savings to be sacred, not to be touched for anything other than retirement (except something truly catastrophic). If I raid my Roth to pay for DD's college, that money won't be there for me when I retire. Just not a good idea IMO.

I agree with you about retirement savings being sacred, but I guess I was thinking that it would be put in the Roth more as a college fund--not to replace other retirement savings.

Anne

 

[Golf4food]

If he really doesn't want to pay towards a college fund, he should do whatever he wants with that extra money (pay down mortgage or whatever) and then instead of using a home equity loan to pay for college he should just take out federal loans for the college and pay those for his kid. A home equity line of credit runs around 7.25% right now? A federal student loan can be had for around 3.0% to 3.5% in most cases. No brainer. Why pay 7.25% on someting that you can pay 3.5% on?

Of course, paying cash is even better, which is the advantage of the college fund (which you earn the interest on until you spend it) or a prepaid college account. Even if he does nothing but put that money in a high yield savings account at 4.5% to 5.0% he'd be making a better return margin compared to the student loan. So he could just save that money and still get the student loan and still have a 1.5-2.0% margin in his favor assuming rates stay roughly the same. Either way, the home equity loan is probably the worst option from a cost standpoint.

But if they can pay off the mortgage before the kid starts school then they would have all that money to pay cash for college as they go. The idea that some people have of not paying off a mortgage because you lose the tax deduction is backwards - why spend $2000 ($24,000 per year) cash per month to save $2000 in taxes at the end of the year? Let me pay that $2,000 at the end of the year in taxes and leave me the other $22,000 in cash and I guarantee I can find something better to do with all that extra cash that won't make me the least bit sad to pay a $2,000 tax bill come the end of the year.

 

[dcfromva]

It looks like a lot of folks are assuming the guy is not already fully funding his retirement account. (Maybe that is a safe bet these days?)

I think saving for college in a retirement fund is usually not a good idea. First of all, you have to rob the retirement fund to pay for college--that is savings that can not be made up again--you are only allowed to make a finite contribution to the retirement funds. In a Roth if you are planning to take a distribution before age 59½ for college expenses, I believe you can only take out the contributions no problem, but you have to pay taxes (no penalty) on earnings you withdraw. That seems silly when you can set up a 529 plan which gives you tax free earnings on qualified college expenses. Plus, does the guy even qualify for a Roth (maybe he makes too much money?)

The 529 plan gives you tax free earnings if the proceeds are used for college expenses. The saving objectives of the individual have to be considered. (At 200.00 per month--the goal is most likely not to cover every expense and any college of the childrens' choice. ) The beautiful thing about a 529 plan is the flexibility--you can change beneficiaries if one decides not to go to college. If a college loan is needed, the 529 money doesn't count against the beneficiary (It is considered an asset of the account owner--usually the parent and the EFC for a loan is way lower that a child's asset).

Some folks have a Roth account set up as frosting on the cake for their retirement--they don't need the money for retirement and they are not certain if their kids will go to college (and they may not be planning to fully fund their kids college with the Roth, anyway). Maybe not a bad idea to use a Roth under these circumstances.

-DC

 

[ducklite]

If he really doesn't want to pay towards a college fund, he should do whatever he wants with that extra money (pay down mortgage or whatever) and then instead of using a home equity loan to pay for college he should just take out federal loans for the college and pay those for his kid. A home equity line of credit runs around 7.25% right now? A federal student loan can be had for around 3.0% to 3.5% in most cases. No brainer. Why pay 7.25% on someting that you can pay 3.5% on?

Of course, paying cash is even better, which is the advantage of the college fund (which you earn the interest on until you spend it) or a prepaid college account. Even if he does nothing but put that money in a high yield savings account at 4.5% to 5.0% he'd be making a better return margin compared to the student loan. So he could just save that money and still get the student loan and still have a 1.5-2.0% margin in his favor assuming rates stay roughly the same. Either way, the home equity loan is probably the worst option from a cost standpoint.

But if they can pay off the mortgage before the kid starts school then they would have all that money to pay cash for college as they go. The idea that some people have of not paying off a mortgage because you lose the tax deduction is backwards - why spend $2000 ($24,000 per year) cash per month to save $2000 in taxes at the end of the year? Let me pay that $2,000 at the end of the year in taxes and leave me the other $22,000 in cash and I guarantee I can find something better to do with all that extra cash that won't make me the least bit sad to pay a $2,000 tax bill come the end of the year.

Very well explained. One other thing to note--even without a mortgage, you can still write off the taxes on a property--and most *most* people the taxes are far higher than the interest paid towards the end of the mortgage cycle. I'm at the begninning of paying off my mortgage, and my property taxes are a full 30% of my monthly payment! If all goes as planned, five years from now my taxes will be more than double the monthly interest payment.

Anne

 

[Lisa_M]

If he really doesn't want to pay towards a college fund, he should do whatever he wants with that extra money (pay down mortgage or whatever) and then instead of using a home equity loan to pay for college he should just take out federal loans for the college and pay those for his kid. A home equity line of credit runs around 7.25% right now? A federal student loan can be had for around 3.0% to 3.5% in most cases. No brainer. Why pay 7.25% on someting that you can pay 3.5% on?

Actually federal student loans at are 6.8% right now they went up from 4.5% last July.

To the OP, I think your friend should use the money to pay off the mortgage and let the kids worry about the college financing. I think it's important for him to solidfy his financial situation before worry about how his kids will pay for college. If he is really adamant about paying for college, then he should make the kids take out the loans in their name and pay the loans for them. I don't think it is a good idea at all take out any loan against the house for college. A lot of kids college hop, flunk out or take 5-7 years to graduate for the above reasons. If the loan is in the student's name, then ultimately, if they don't follow through on their part of the bargain, it's still their responsibility to pay the debt back. The bad part of this is that the student will be able to claim loan interest paid and not the parent.