Paying for College: Tap Your Home's Equity?
Our Son is Heading Off to College – Where’s the Money? Our Home?
We’ve been talking to a lot of parents and they’re all wondering how best to pay for college. Even with the real estate market still in the doldrums for the most part, many parents do have equity. That’s an option, but one you shouldn’t take lightly. Taking out a loan against your home reduces your own “piggy bank,” which you might need for retirement or an emergency. Plus, your son or daughter has many more years of earning ahead of them than you do – albeit in a tough job market.
The Big Change: Student Loans
One of the biggest changes regarding school-based student loans is that they are now all backed by the government – no more private loans. You complete just one form and the college will then give you your funding results. Some loans, like the unsubsidized Stafford, carry higher interest rates but don’t require that the funds be paid back until after graduation. Then, there are loans based on your financial need, such as the Perkins loans, which offer lower rates and may allow your debt to be forgiven if you work full time for the government or a nonprofit for at least 10 years.
So what about tapping your home’s equity? You could tap your home’s equity with a loan that, today, runs about 6 percent. Or, you could take out a home equity line of credit at rates that currently run about 4.5 percent, enabling you to draw down on the money as you need it, much like a credit card. Those rates are variable so they can go up or down and possibly cause havoc on your finances if you’re not careful. With both types of home borrowing, unlike the loans above, you have to start paying immediately. However, the interest is tax deductible, making them especially attractive.
What does this tax-deduction mean, really? For that, you need to know your marginal tax rate. Let’s say your federal income tax rate is 25 percent and your state’s tax rate is 5 percent (though they vary). Together, your tax rate is a combined 33 percent. Your after-tax rate on your home equity borrowing is the inverse of the 33 percent – or 67 percent -- multiplied by the rate itself (say, 6 percent). So, a 6 percent home equity loan would actually be about 4 percent – much better than the regular Stafford loan and perhaps even lower than a subsidized Perkins. The big risk with borrowing against your home is… what if you can’t make the payments one day? Well, you risk the chances of foreclosure – losing your home altogether.
Perhaps borrowing from your home – especially a home equity line of credit – should be considered only if you have a clear path to repaying it. In other words, be sure you know how and when you’ll be able to pay it off – or you could run the risk of higher rates, not to mention the possibility of not being able to retire in your own home.
These decisions are tough. But don’t forget that, in today’s economy, your own financial health may be as important as your child’s. Weigh the pros and cons and, whatever you do, be sure you have a plan for repayment. Having a “Plan B” just might be your ticket to a SuperFuture!