When their youngest daughter entered college, Leah Ingram and her husband refinanced their 30-year mortgage to find extra money for college bills. They had contributed to 529 college savings plans since their two girls were little, but they also needed to pull from their current cash flow.
With excellent credit, they were good candidates for the home refinance, which lowered their interest rate a full percentage point and reduced their mortgage by around $400 per month. That money made a difference for them.
If you’re a homeowner, another strategy to consider is paying your mortgage aggressively while your children are young. This helps you build up equity — or even pay off your mortgage in full — to pay for college.
“People who are diligent savers and understand something about personal finance might keep home equity back of mind as a payment strategy,” says Judith Ward, a Maryland-based senior financial planner at T. Rowe Price.
Not everyone is in a position to tap their home equity or pay off their home to fund college expenses. Financial planners say there are pros and cons to consider.
Weigh [whether to use your home to pay for college.]
Pros
Paying off your mortgage before your child starts college frees up cash you can use for tuition bills, says Kyle Moore, a Minnesota-based certified financial planner and founder of Quarry Hill Advisors. But just making more than the monthly mortgage payment will slash the interest you pay and shorten the life of the loan, building equity faster and giving you more flexibility when it comes time to pay for college, Moore says.
Even if you don’t pay off your home entirely, substantial equity — and good credit history — allow you to consider refinancing to a lower mortgage to free up cash or opening a home equity line of credit.
Cash-out refinances are a possibility as well, but extra money sitting in a savings account could affect financial aid. Finance experts agree that for a family with good credit and a stable financial situation, home equity combined with a college savings plan can be an effective strategy.
The reality, though, is that most families must rely on multiple income streams to pay for college, Ward says .
Consider the [risks of borrowing from yourself to pay for college.]
“It’s always better to meet tuition obligations through savings or cash flow, but if you’re behind on saving for college, tapping home equity can be better than a Parent PLUS Loan,” Moore says. For example, the average interest rate on a line of credit in 2016 was just over 5 percent, with some as low as 3.5 percent, while the 2017-18 Parent PLUS loan rate is 7 percent, with a 4.264 percent origination fee.
Similar to a credit card, a home equity line of credit allows you to borrow the exact amount you need to avoid a home loan balance sitting in your savings account. Keep in mind, though, that good interest rates will depend on your credit score, loan type and institution.
An added benefit: The Free Application for Federal Student Aid — commonly known as the FAFSA — doesn’t calculate home equity on your primary residence in the financial aid formula. If you qualify, this may mean you’re eligible for more financial aid.
But where your student applies will be key. The CSS Profile, used by some 280 institutions and programs, does calculate home equity.
Cons
Using your house as collateral could be dangerous, since you risk losing it if you can’t make payments. And taking a big loan or drawing heavily on a home equity line of credit could lead you to incur more debt than your home is worth, if its value drops. Refinancing to a lower mortgage doesn’t pose the same risk, but it may not free up enough money.
For young families, the biggest consideration for paying down a mortgage to build equity is whether you can do this and meet your savings goals. This may not be the best use of your paycheck if it prevents you from adequately funding retirement or a tax-advantaged college savings plan with a higher return than a low-interest mortgage.
Read about [three student loans for parents to fill a college tuition gap.]
“You have to consider the opportunity cost of money going to the mortgage when it can help you reach your other financial goals,” Ward says. “If you can start as early as possible saving in a 529 plan, you get the advantage of tax-deferred compounding interest and tax-free withdrawals for qualified education expenses,” she says. It’s also wiser to first pay off credit cards, car loans and other higher-interest debt and put funds toward a college savings plan.
Remember, too, that your ability to tap home equity will depend on your future credit scores and home value, so it’s not a predictable plan. Even if you’re able to pay down a mortgage, the equity you bank on may not be accessible if home values drop or your credit score decreases, says Nannette Kamien, owner of Inspiration Financial Planning in the San Diego area. A college savings plan offers a more accessible, tax-advantaged and predictable savings option.
And while Parent PLUS loans generally come at a higher interest rate than borrowing against your home, depending on your credit score, they offer consumer protections, including consolidation and graduated and extended repayment options. And with Parent PLUS loans, your home isn’t on the line.
Prioritizing mortgage payments with the focus of using the cash savings to pay for college isn’t an option for everyone, but as your child grows and your financial situation changes, this could become a viable tool for funding your child’s education.
Trying to fund your education? Get tips and more in the U.S. News Paying for College center.
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Pros, Cons of Paying Down a Mortgage to Fund College originally appeared on usnews.com
