<p>Hi All, especially our financially savvy folks. I got some great advise the last time I posted a question, and now I have another one for you... </p>
<p>Our son will be a freshman in HS. We have a 529 but unfortunately we also have home equity debt at about 6% interest rate. We could pay off the debt in about 2 years if we really buckled down but I am torn as to if we should do that, then crank up the investing in the 529, put money into both, or what approach we should take. Thanks for your input.</p>
<p>Suze Orman will tell you to pay off the debt first, but that’s not necessarily right from a pure financial analysis perspective. Your home equity debt ought to be tax-deductible, so (depending on your effective federal/state tax rate), your after-tax interest rate is probably somewhere in the 4-5% range. Earnings in the 529 plan are not taxed as long as they are used for qualified expenses. So if you think you can earn 5% or more on amounts invested in the 529 plan, you will be better off doing that than paying off the home equity debt. </p>
<p>That’s not a laydown to achieve these days, but it’s hardly impossible, either. There is risk involved – if you try to invest the 529 plan to earn 5% or more, there’s some chance you could actually lose money, not make it. There’s also upside – you could do better than 5%.</p>
<p>Take into account the amounts we are talking about, too. For every $10,000 of principal you pay off, you will save about $900 after tax in the next two years that you could use for college. For every $10,000 you put in the 529 plan with 5% earnings, you would earn $1,102 over the next two years that you could then use for college. It’s up to you to decide whether the additional riskiness of the 529 route is worth the extra $200 towards college it might produce.</p>
<p>You may or may not be able to get another home equity loan- depends on your home’s value at the time. In our area homes dropped so far they may not recover their prior value for years. if we had counted on taking a home equity loan for college, we would have been out of luck.</p>
<p>JHS does make a good point though. The 529 interest growth rate has far exceeded the interest rate that we have to pay for the equity debt that’s why I hesitate to pay off the debt first… I really appreciate all of your input, keep it coming, and if you can tell me your opinion why we should do what you recommend, that would be great too.</p>
<p>I would have to agree with paying off the house. Some privates Us will not consider the house as an asset for FA, some others will limit how much they consider for the house. At worst it would be assessed at the same rate as the 529 (5.6%).</p>
<p>I saw a program on TV, not long ago, arguing that 509 programs are basically tax heaven for really rich people, but useless for middle and upper midle folks. Forget exactly what it was…</p>
<p>Factor in whether your contributions to the 529 will be tax deductible for your state income taxes. That can result in nice tax savings for middle income families.</p>
<p>Also, as you get closer to paying off your home equity loan, you may fall below the federal standard deduction amount. At that point, there is no federal tax advantage to having any debt on your house.</p>
<p>In addition, keep in mind to maintain an emergency fund. Many things can occur quickly that can result in unforseen expenses. That is why most financial aid formulas do not consider the first $40,000 to $50,000 of family savings and investments, because they feel that should be set aside for emergencies. Unfortunately, the emergency funds of many families disappeared during the Great Recession, and now they have to be built back up.</p>
<p>Overall, if you have enough emergency funds, it is usually best to pay off debt before doing anything else. That is because financial aid formulas typically don’t give anyone a break because they have debt.</p>
<p>I would consider refinancing that home equity loan with a no-cost HELOC. Right now PenFed is at 3.75%, and you can even lock it in for 5 years, with a 5/5 HELOC. Then you have the flexibility to pay it down, contribute to the 529, or at least you’d have some choices. 6% is pretty bad right now, unless of course, you are stuck with not enough home equity to refinance.</p>
<p>I agree with JHS and busdriver. Charlieschm brings up good points to consider too such as the deductibility of the 529 from state income taxes and making sure you have enough emergency fund. There are so many variables. Presuming you have a good 529 plan and its performance is above 5% since inception, I would, after following busdriver’s suggestion, put the extra money towards the debt. Did I confuse you? Right now, presuming you are investing in an equity 529 plan, you will be buying when the market is at all time highs. When the market dips then that’s the time you scale in to the 529.</p>