Dear Dr. Don,
I have a 15-year mortgage with 57 monthly payments left at 5.5 percent interest. I owe about $44,000 on this mortgage. The home is worth about $300,000 if sold today. My daughter will be a freshman in college this fall. Tuition, room and board, books, expenses, etc., are estimated to run $34,500 for her freshman year. We did not qualify for grants or scholarships. My daughter did qualify for a federal government loan in her name of $5,500 for her freshman year. Additionally, I have a 529 plan that will provide about $12,000.
My daughter's loan and the 529 plan will provide about half of her first year college expenses. To pay for the other half, should I take out a home equity line of credit? Perhaps I could refinance the house and take money out of it. Or I could take a federal government parent college loan called a Plus loan with a rate of 7.9 percent.
I have tried to find out if the interest on the Plus loan is tax deductible. I understand that if I refinance my house and pull money out and park it in a savings account, the money will be considered an asset that could hurt me when it is time to reapply for financial aid for my other daughter, now in high school. That's unless I've spent the money by then.
On another matter, if you recommend the government Plus loan, is there any point to trying to refinance my $44,000 mortgage by itself, without taking any equity or money out of my house?
Thanks for any advice!
-- Steve Scholars
You've done a great job managing your mortgage debt, but a not-so-great job of saving for your children's college education. I like that you want your daughter to have some "skin in the game" by taking out Stafford loans (in her name) up to the available limit.
Financial aid offices and even government financial aid websites won't give tax advice. Your ability to use a student loan tax deduction is based on your adjusted gross income level, filing status and educational expenses paid with nontaxable funds. The Internal Revenue Service has an interactive work sheet on its website titled, "Can I claim a deduction for student loan interest?" that might help.
If you decide to use a home equity line of credit or loan, or a cash-out first mortgage, you'll also want to consider the tax deductibility of the mortgage interest expense. These mortgage loans will probably both be at a lower nominal interest rate and a lower effective rate, or after-tax rate, than a Plus loan. Although it's an adjustable-rate loan, a home equity line of credit is generally the better option for financial aid eligibility.
You should be concerned about the impact of lump-sum proceeds from a loan sitting negatively affecting your daughter's aid eligibility next year. But you didn't have the extra money this year, and she was eligible for only $5,500 in student loans -- the first year limit for Stafford Loans.
It sounds as if her aid package only includes the opportunity to borrow money in her name.
I'm concerned about financing your younger daughter's education after possibly tapping all the available equity in your home for your older daughter. If the younger child goes to a similarly priced university, I estimate over a quarter million dollars of your wealth going toward college costs over the next eight years. That doesn't include their Stafford loans.
I'm not recommending the Plus loan. But refinancing a $44,000 mortgage at 5.5 percent with less than five years to go isn't likely to generate much in savings if you pay the typical average of several thousand dollars in closing costs.
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