Use home equity to pay off student debt

By: Savingforcollege.com

Q:

Dear Joe, My daughter and son-in-law are considering taking out a home equity loan to pay off his student loans. They think the interest rate will be lower. Is this a good idea, or should they try to work with the student loan people to consolidate as best they can? These are private student loans. -- Cheryl

A:

Dear Cheryl,
By all means, they should consider refinancing those loans with a home equity loan.

I'm not surprised to hear that your daughter and son-in-law can find a home equity loan with better terms than what his current loans carry. Banks will usually offer a lower interest rate when the loan is secured by the equity in real property. A private student loan typically has no security other than the personal guarantee of the borrower and (often) a co-signer.

Furthermore, home equity loans are often available at a fixed rate of interest, whereas private student loans are usually variable-rate. For many borrowers, a fixed rate is more appealing if they wish to avoid the possibility of interest-rate increases in the future. In comparing options, be sure to consider the upfront costs of a refinancing or loan consolidation.

Your daughter and son-in-law should also consider the income tax consequences of refinancing the student loans. They may currently claim a federal tax deduction for up to $2,500 in student loan interest paid each year, although the deduction phases out above a certain income level. For 2008, the phaseout range for joint filers is $115,000 to $145,000 in adjusted gross income.

Interest on up to $100,000 of home-equity indebtedness is deductible regardless of income, but only if the taxpayers are itemizing their deductions and are not subject to the alternative minimum tax, or AMT.

There is a downside of going with the home equity loan. Your daughter and son-in-law risk losing their home if their finances go sour and they are unable to keep up with their payment obligations. On the other hand, such an outcome is unlikely if your son-in-law sticks with private student loans.

Popular Questions

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Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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