Mortgage Strategies for Funding a College Education

By Ken Roberts

Many of us have heard the old saying, “An ounce of prevention is worth a pound of cure.” When it comes to financing a child’s college education, it changes to "an ounce of planning…” As the cost of college tuition continues to soar, it is imperative to figure out just how you are going to pay for it. For some, tapping home equity from their greatly appreciated primary residence is an answer. But for first-time home buyers struggling to scrape together the money for their first home purchase, banking on future appreciation to finance their children’s future is far from a certainty and not without risk. As a certified mortgage planning specialist, I work with clients’ CPAs, financial planners and investment advisors to determine where they are, where they are trying to get to and how will they get there. Just like planning for retirement, you should start planning early and often.

One college savings planning tool that works particularly well is the 529B. It allows you to save pre-tax dollars and invest them tax deferred. Some allow you to lock in today’s tuition rates for tomorrow’s education. Distributions can be used for any qualified higher education expenses and maybe federal and state income tax-free. There are no income restrictions and the beneficiary can be changed to any eligible member of the original beneficiary’s immediate family at any time without penalty, including use for education funding for your further education if your child or grandchild doesn’t use the funds. Check with a qualified investment advisor for details and restrictions.

A successful strategy for finding extra money to fund a 529B monthly is through the use of an alternative mortgage product. Today, a mortgage is no longer just a mortgage. It is a financial instrument that can be woven into the fabric of your short and long-term financial plan to give you liquidity, safety and a greater rate of return. The interest-only mortgage is a very powerful financial planning tool when used properly. In this instance, it gives you the flexibility to take funds that would normally go toward principal reduction in a traditional 30-year fixed loan and use that money to fund your 529B. Unfortunately, it has been much maligned by the media and lumped in with the negative amortization loans that allow the borrowers to pay much less than they actually owe each month, putting them at risk of defaulting in the future and potentially losing their homes. The beauty of the interest-only loan is that it gives you options. The minimum payment is just the interest on your outstanding balance and each month you get to decide what to do with the funds that you would be forced to pay toward principal in a fully amortized loan. Each month you can either fund the 529B, pay down credit card debt, pay off auto loans or invest additional funds in the stock market. One month, allocate money for the 529B. The next month, make additional payments to credit card balances. It’s your choice.

In the early years of any fully amortized loan, the amount of principal paid down is not that significant. The difference between making your entire mortgage payment fully tax- deductible with the interest-only option and investing those funds that normally go toward principal reduction and getting a compounded rate of return over time is huge. It is one way wealth is created. The higher your marginal tax bracket, the more your rate of return is accelerated. You are maximizing tax write-off while putting what I call “lazy equity” to work for you. Remember, whether it is equity in your home with no rate of return or equity in an investment account that is working hard-paying interest or dividends, equity is equity.

Banks make money by taking your money, paying you a modicum of interest and loaning your money out at a higher rate and keeping the spread. It’s called arbitrage. You need to create the opportunity to have your assets working as hard as they can for the longest time frame possible. Because equity in your home provides no rate of return, your home as an investment will appreciate at the same rate if it is paid for or mortgaged to the hilt. That, along with the realization that if your home is free and clear of a mortgage your equity is actually not safe, means you should investigate all the options available to you. See if there isn’t something else you could be doing that is prudent and within your risk tolerance to separate some of the equity from your home.

A recent paper published by the Federal Reserve Bank of Chicago entitled “The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings” states that “a significant number of (American) households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts (TDA).” It further states that “we show that about 38 percent of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice…..these misallocated savings are costing the U.S. households as much as 1.5 billion dollars per year.” It seems even the Fed believes it is a mistake to prepay your mortgage instead of funding either a tax-deferred 529B or retirement account.

There are many safe, proven techniques to reposition equity so that it can provide a greater rate of return allowing funds to be available for college education costs, a comfortable retirement and the creation of a substantial legacy for future generations. And it is all made feasible by starting as early as possible with some planning and a little discipline. Another old saying couldn’t be truer: “People don’t plan to fail, they fail to plan.” Make an appointment today with your investment advisor and mortgage planner and get started. Once apprised of your viable options, you’ll have the peace of mind of knowing that you have not left your future and your children’s future to chance.