College Savings Category
Dear Liz: I’m facing the end of child support and need to finance my son’s college education, plus I have some home maintenance costs looming. Should I get a home equity loan or line of credit (assuming I can qualify) to pay off these pressures, or should I raid my retirement fund? I am 60, make about $80,000 a year and have no debt besides the mortgage and a car loan, but I have only about $100,000 in retirement accounts. (I had to wipe out my savings once before in a two-year spell of unemployment.)
Answer: There’s no polite way to put this: You’re too old and too inadequately prepared for retirement to be paying for your child’s college education.
It isn’t a good idea to raid retirement funds prematurely in any case, but certainly not when you have so little saved. Borrowing to pay for school would make sense only if you were adequately prepared for retirement and had plenty of time before then to pay off the loan.
Even if you plan to work into your 70s, life may interfere. Nearly 40% of retirees interviewed by the Employee Benefit Research Institute say they had to quit work before they wanted to, typically because of layoffs, poor health or the need to take care of a family member.
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You must focus on building up your retirement fund as much as possible while you still can. That means your child will need to figure out how to pay for college on his own. Many students save money by attending a community college for two years while living at home, then switch to a four-year public institution to finish their degrees. Your son may qualify for scholarships or grants; if not, federal student loans can help him pay the bills without sinking too far into debt.
You really shouldn’t be borrowing for home maintenance costs either. Ideally, you would have set aside money from your current income that’s earmarked for these costs. If the repairs are pressing, however, you can pay for them with a low-cost home equity line of credit and then repay the loan as quickly as possible.
Dear Liz: As a student I was not aware of finances as much as I should have been and borrowed too much. I have about $60,000 in student loan debt plus an $11,000 car loan. I am contemplating going back to school because the job I really want — to be a counselor — requires that I have a master’s degree. My friends say I’d be crazy to go into that field because the pay isn’t that high and I would most likely incur more debt. I am hoping to get scholarships and grants or pay out of pocket as I go. I currently pay all my bills and am really tight with spending. I want to take this leap without destroying my financial future. Any advice?
Answer: In general, you shouldn’t borrow more for an occupation than you expect to make the first year out of school. If you check the U.S. Department of Labor Statistics, which tracks pay for various occupations, you’ll see that the median wage for counselors depends on their specialty (vocational counselors get paid more than rehab counselors, for example), but the median wage tends to be in the $30,000-to-$50,000 range. Expect your starting salary to be somewhat lower.
That doesn’t mean you can’t go back to school, but you probably shouldn’t take on more debt to do so. You can apply for financial aid but expect stiff competition for grants and scholarships — most aid comes in the form of loans. Your best bet may be to attend a public college, perhaps at night so you can keep your day job. For more on attending college without loans, read Zac Bissonnette’s “Debt-Free U: How I Paid for an Outstanding College Education Without Loans, Scholarships or Mooching Off My Parents.”
Dear Liz: I’m an estate-planning attorney and want to expand on the answer you gave to the parent who wanted to give her children money for their educations or a car but was worried about gift taxes.
Your explanation of the federal rule was accurate — only gifts of more than $13,000 per recipient have to be reported, and gift tax isn’t owed until amounts over that exclusion exceed $1 million — but state laws vary. (California levies no gift tax.) In addition, the $13,000-per-person annual exclusion and the $1-million lifetime exclusion is available for each giver, so a married couple could give $26,000 without reducing their lifetime exemptions.
Also, tuition is not considered a gift if paid directly to the school, irrespective of the amount, so the giver could offer to pay tuition directly and then give money separately for a car. Finally, 529 college savings plans are an excellent way to save for a child’s higher education and are often preferable to giving money directly to the children.
Answer: Thanks for the additional information. College savings plans allow people to contribute up to five times the annual gift exclusion amount at one time, meaning generous parents or grandparents could stow $65,000 into a 529 plan in one lump sum (as long as they make no other gifts to the recipient in that five-year period).
Dear Liz: My daughter is a sophomore at a very expensive college, and federal loans cover only $6,500 of her costs. She has taken out two private student loans with me as a cosigner, one at 6.5% interest and the second at 9.9%. I need $15,000 more for this semester’s tuition. I am an unemployed single mother but cannot get much financial aid. She is an above-average student but cannot find any awards or scholarships.
Answer: Your daughter may need to look for a less expensive education, since it appears neither of you can really afford the one she’s getting.
Unlike federal student loans, private student loans tend to be expensive, with variable rates and less flexible repayment options. Borrowers can easily find themselves taking on far more debt than they will be able to repay after graduation, yet this debt typically can’t be discharged in bankruptcy — it can follow your daughter for life.
A better option, if you must borrow, is for you to take out PLUS loans. These are federal loans for parents and graduate students that allow you to borrow the difference between your daughter’s college costs and any financial aid, including federal student loans, she gets. The rates are fixed at 8.5% or less.
PLUS loans do require a credit check. If you don’t pass — you’re 90 days or more overdue on a bill or you’ve had a bankruptcy in the last five years, for example — your daughter’s eligibility for student loans would be increased somewhat to help compensate.
But both of you should be thinking about alternatives. You really shouldn’t borrow money if you don’t have a way to pay it back. When you’re unemployed, taking on $15,000 a semester in debt is pretty foolish.
If her school won’t reconsider her aid package in light of your unemployment, she should be researching less expensive schools to which she could transfer her credits.
Dear Liz: I have twin boys and have been looking for a college fund to set up for them. Most bank saving accounts don’t pay much interest. The only thing I have found that is halfway decent is a certificate of deposit. My grandmother set up a trust for me, but I don’t know whether that’s a good idea these days. Do you have any ideas that would help?
Answer: You’re actually asking two questions. The first is what vehicle to use for college savings, and the second is how to get a decent return on your money.
Let’s take the latter question first. Bank savings accounts or certificates of deposit are fine if your kids are headed off to college in a year or two, but these low-risk investments won’t give you much growth on your money. In fact, you’ll almost certainly lose buying power over time when you consider inflation. If your money is in a taxable account, you’ll lose that much more.
Many parents opt to take more risk in order to accumulate more funds. If college is 10 years or more in the future, investing at least some of the money in stocks or stock funds makes sense.
The vehicle you use is also important. If you expect to get financial aid, you’d be better off avoiding custodial accounts such as Uniform Transfers to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) accounts. These were popular accounts years ago when tax rates were higher, but they count heavily against you in financial aid formulas.
Many families find 529 college savings plans to be the best choice. These state-run accounts allow your contributions to grow tax-free for college and are treated favorably in financial aid calculations. These plans typically offer a choice of investment options, including age-weighted options that start out more heavily invested in stocks but that ratchet back exposure to risk as college draws closer. For more information, visit SavingForCollege.com.
Dear Liz: Are banks still lowering the amount of available credit? I’m concerned because we were hoping to use our home equity line of credit to pay for our children’s college educations, if need be.
Our current balance is less than 5% of the total available limit, but my credit reports show our credit line lender recently reviewed our credit history. I am concerned that our bank will lower our available credit as my son is about to start college. Are my concerns valid?
Answer: Perhaps. Lenders have been reducing home equity lines of credit as home values drop. If your mortgage balance and your line of credit total more than 60% of the current value of your home, you may be at risk of having your limit reduced right when you planned to use it.
If that’s the case and your son is heading off to school in the next year, it might be prudent to withdraw the money now and keep it in a savings account.
If college won’t start for several years, though, you might want to explore other options, since it’s generally not a good idea to borrow money so far in advance of when you’ll need it.
Fortunately, you have plenty of options when it comes to paying for college. Just make sure you fill out a Free Application for Federal Student Aid. Even if you don’t qualify for need-based aid, filling out the FAFSA will allow you to apply for federal student loans. Your son can get Stafford loans at a 6.8% fixed rate and you could get PLUS loans with a fixed rate ranging from 7.9% to 8.5%. Although the amount of student loans your son can get is generally limited to $31,000 for an undergraduate degree, PLUS loans allow you to borrow whatever you need to cover any costs not paid for by the student’s financial aid package.
Dear Liz: I would like to know how best to use a $100,000 inheritance. I am a stay-at-home mom, age 46. My husband, 42, earns $100,000 a year.
We owe $132,000 on our house and have no other debt. We pay off our one credit card in full monthly. He puts the maximum into his 401(k). We have two sons, ages 5 and 8.
Should we use the money to pay down our mortgage? I’m not interested in saving for college. We will be retiring about the time the kids are ready for college and we plan to have them take out student loans.
Answer: If you can save for college, you probably should.
College costs show few signs of moderating, so your older child might face a bill of $140,000 for an in-state public college or $200,000 or more for a private or selective public college. The cost for your younger child will be even higher. If they borrow the entire cost, they’re likely to remain financially disadvantaged for years. Students who overdose on loans often can’t save enough for retirement and delay starting families and buying homes because of their debt. Anything you save for them could reduce that terrible burden.
You also might want to rethink the idea of retiring when they start college. Even if your husband has been maxing out his retirement fund, it’s unlikely he’ll have saved enough by age 52 to last the rest of your lives, particularly if you have to start paying for health insurance on your own. (Medicare isn’t typically available until you’re 65.)
You didn’t mention savings. Most people should have an emergency fund equal to three months’ expenses, but families with just one earner typically should shoot for six or even nine months’ worth.
In any event, you almost certainly have better things to do with your money than pay down low-rate, potentially tax-deductible debt such as a mortgage.
A better approach might be to divide your inheritance into thirds, investing a third into an emergency fund, a third into your boys’ educations and a third into retirement funds.
A visit to a fee-only financial planner could help you sort through your options and clarify your goals.
Dear Liz: I have been accepted to my dream school. However, the school isn’t giving me much aid and I am expected to pay $50,000 a year, or a total of $200,000, if I get through college in four years. Although that is a huge amount of debt to carry, I think a cosmopolitan city would provide useful networks for me as a business major. What is your opinion on this?
Answer: As a business major, you’ll be doing plenty of cost-benefit analyses. Do one now, before you chain yourself to a lifetime of debt.
The general rule of thumb is not to borrow more for an education than you expect to make your first year out of school. A basic business degree is highly unlikely to land you a $200,000-a-year job.
What’s more likely is that you’ll need an MBA to vault into the high-paying leagues — a degree that will require further borrowing.
Understand that massive student-loan debt will have repercussions for the rest of your life. Since this debt can’t be erased in bankruptcy, you’ll be saddled with huge payments that could prevent you from buying a home and saving adequately for retirement.
What makes more sense is tweaking your dream a bit to get an education you can afford. And here’s the good news: Students accepted to Ivy League schools tend to do well in life regardless of the institution they actually wind up attending, according to research by economists Alan Krueger of Princeton University and Stacy Dale of the Mellon Foundation.
So choosing a less-expensive education doesn’t mean diminishing your prospects. Saying goodbye to your dream school will be sad, but far sadder is throwing away the rest of your financial life with too much debt.
Dear Liz: Our question is about student loans.
We have a total of $69,000 in education debt. We also have a home worth $400,000 and our mortgage balance is $266,000, plus a home equity loan with a balance of $14,500.
We make a good salary, have excellent credit, pay all our bills on time, and, if gas weren’t so darn high, we would have a decent amount of discretionary income.
We make extra principal payments when we can. The problem is that interest rates on our school loans are climbing, and payments are getting higher and higher.
We’re wondering whether we should take out another home equity loan to pay off the student loans.
That would obviously leave us with less equity, which could limit the price we could pay on the house we plan to buy in three to five years.
But it would also decrease our monthly loan payment significantly and we would be able to deduct the interest on the home equity loan. (We can’t deduct student loan interest because we make too much money.)
Does a home equity loan make sense in this case?
Answer: Generally speaking, trading student loan debt for home debt isn’t a great idea.
Student lenders typically are much more flexible than mortgage lenders, with a wider variety of repayment options. You also can get a deferment or forbearance if you lose your job or otherwise encounter a financial hardship. This respite from payments can last as long as three years on many student loans.
Compare that with what would happen if you couldn’t make your mortgage payments. Within a year, and usually much less, your home lender would start foreclosure proceedings.
In addition, most student loan debt can be consolidated. This would allow you to lock in your current interest rate and perhaps lengthen the repayment term to lower your monthly payments.
A longer loan means you would pay more interest over time, but it could help ease the monthly crunch you’re feeling.
All that said, not being able to deduct the interest on your student loans is a significant disadvantage.
If you’re confident you’ll be able to make the payments, then you might consider paying off at least some of your student loan debt with home equity borrowing.
You should, however, limit your total borrowing â€” all your home equity loans plus your primary mortgage â€” to no more than 80% of the value of your house.
You want to keep at least a 20% equity cushion in your home whenever possible, as a last-resort emergency fund and also to protect yourself in case of declining home values. (You don’t want to be faced with having to sell your home and owing more than it’s worth.)
Given the loans you already have, you should be able to pay off $39,500 of your student loans with home equity debt. Then you could consolidate the remaining $29,500.
Q: We are facing a challenge in regard to financing our son’s education. We are being asked to contribute $30,000 a year for a private college education. Is this really a wise move? We have a daughter who will be in college in two years. Help!A: A good education is virtually essential to success in today’s competitive, global economy. That said, there are plenty of ways to get a good education, and bankrupting yourselves on a too expensive college shouldn’t be one of them.
If you can’t manage this bill without sacrificing your own retirement plans or your daughter’s education, then you need to think about some options.
If your son has his heart set on this college, then he should be willing to take on at least part of the cost by incurring student loans. (He should be careful, though, to make sure that his total student loan debt doesn’t exceed the salary he expects to make in his first year out of school.)
Another option, obviously, is for him to attend a less expensive school for at least a couple of years, if not the duration of his education.
The fact that you’re asking this question just months before your son starts college indicates that you haven’t done enough thinking and planning, but it’s not too late.
Head to the bookstore or library and grab a copy of a college financing guide and explore your options. You might also use FinAid.org’s expected family contribution calculator, available at http://www.finaid.org , to estimate how much you’ll have to kick in once your daughter starts school.