Marketplace

Education: Debt or Savings

Question: My husband is planning to start a two-year Master's degree program next fall (2008) which will cost about 24,000 total. We have enough money in savings to pay for most of the tuition, but I wonder whether it would be wiser to take out student loans for all of it and let our cash stay in the bank to earn interest for those two years. (We have no other debt other than a mortgage.) Suzan, Minneapolis, MN

Answer: To some extent this is a personal choice or preference. Some people in your financial circumstances just don't want to take on any debt. They prefer to pay out of savings. Clearly, that's a sound option.

But I'd like to argue for borrowing some to most of the money needed for the Master's program while leaving your savings alone. The reason is that when your husband graduates you could face a number of different choices, including moving to another city for a better job. Now, that may or may not be in the cards, but by keeping your savings your decision about what to do won't be constrainted by money when he graduates. And since there is no prepayment penalty with student loans, you can always pay off the debt at that time.

12/18/07 by Chris Farrell

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Student Loans

Question: A few weeks ago you advised a woman with a college-age daughter that there was not a big advantage to paying off her student loan early. I have a related question.

I recently went back to graduate school and had three separate loans for about $18,000 each, one for each year I was in school. I consolidated the first two years into one loan at an interest rate of about 3.5% but didn't consolidate for the final year because that year's interest rate was already getting very high. So I now have two repayments of about $250/month, one for the first two years, one for the final year by itself. I was considering an early repayment of that final year's loan which is currently at about 5.5%, higher than the average savings account interest, and which I assume will go higher.

But your earlier advice made me wonder if that was wise in my case, or did it only apply to college loans? Thanks! Becca

Answer: Every situation is slightly different. If I remember the earlier question right, it involved a short-term trade-off between husbanding savings and paying down debt. In your case, my impression from your question is that it's a savvy move to get rid of the higher interest rate student loans. As you know, it's always a relief to get rid of debt.

01/09/08 by Chris Farrell

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College Choice

Question: My son, a high school senior, was accepted to one of Minnesota's private colleges. We have been fortunate in that we invested over the years and have saved enough for about 3 years of his education at this school. He also received scholarships to a different MN private college that would pay for about 66% of his costs for 4 years, leaving him with a substantial amount of $ at graduation. I have 2 questions. He wants to turn down the scholarship and go to the other school. There is a difference in the 2 schools, one has a very strong regional reputation and the other a national reputation. He wants to forgo the scholarship for the national reputation. From a long-term $ perspective, what advice would you give to him? Second, assuming that he forgoes the scholarship, I am considering keeping the $ we saved for him invested and taking out loans to cover the cost of the education and then paying off the bulk of the loans at graduation. Is that a solid strategy? The investment has averaged 10% over the long term. Thank you for your advice. John

Answer: This is one of those times when the outcome of a financial decision is positive no matter what, yet people strongly disagree about the answer. Some of my friends are adamant that it doesn't pay to attend the more expensive, nationally known school. They'd leap at the scholarship money. Over the course of a lifetime, the importance of that degree shrinks, and the dollars saved add up. Other friends believe the national reputation is worth it if the student expects to attend graduate school, move to another part of the country upon graduation, or enter certain professions, like investment banking. To them, the extra money you're paying is the price of an "option" on a particular career choice and geographic mobility.

So, where do I come down? What strikes me over the past 30 years is just how good college and universities have become, including small private liberal arts colleges. The gaps in performance and quality have really narrowed even if national rankings haven't kept up with the transition. But your son has also expressed a clear preference for the better known school. One way to make this decision is insist that your son "own" more of his education. If he goes to the regional school, he graduates debt free--and that is a genuine advantage these days. He'll be in a position to choose a job at graduation based on desire (and perhaps a low income) rather than face the pressure to take a less desirable job that pays more because he has student loan bills to meet.

If he still wants to go to the other school, then I would have him borrow at least some money to pay the difference in costs himself. He won't graduate debt free. Instead, along with his diploma he will get a student loan repayment booklet. I think making the decision this way is a good life lesson.

That said, I would limit how much he borrows so that he still has a choice at graduation. For one thing, you have the savings. For another, you don't want him too burdened by debt. By the way, it can be a good strategy to borrow, even if you have the money, if there is a reason to keep your options open. You can always help them pay off their student loans at that point.

01/31/08 by Chris Farrell

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529 Plans

Question: How does a 529 plan affect a person in terms of financial aid eligibility? Samir.

Answer: The terrific thing about 529 savings plans is how many pitfalls it sidesteps. Your money compounds tax free. And when the money is withdrawn to pay for qualified college expenses, it's free of Uncle Sam's grasp. Most colleges and universities count it as a parental asset in the financial aid formula (meaning parents are expected to fork over 5.6% of their assets, which is much lower than the 20% figure applied to student money.) However, private colleges and universities are free to make their own rules and percentages. The bottom line: It pays to save for college, and a 529 plan is one of the best options available. .

03/11/08 by Chris Farrell

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Savings for Child

Question: my wife and I just had our first child. We are wondering what sort of investment/saving plan would be the best to start for him. We are looking to invest $100 a month. Thanks. Michael, Seattle.

Answer: Congratulations. First of all, you can't go wrong putting money on a regular basis into a tax-sheltered 529 college savings plan. That said, I have one other thought. How about putting the monthly savings into a broad-based equity index fund with razor thin fees (such as the Standard & Poor's 500 index, Russell 3000, Wilshire 5000, and the like). The savings is in your name. In 16 to 18 years, you'll have accumulated a nice pot of change. You can spend it on your child's college education. But maybe your child will get good scholarships. Then you can spend the money on yourselves, or perhaps create the family trip of a lifetime. You gain a lot of flexibility with this approach.

04/04/08 by Chris Farrell

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Saving for College

Question: On average, we save about $1000 a month. $500 of it goes to a 529 college savings plan for our son (he's about two years old). $200 goes to two Vanguard index funds (Total Stock Market and Total International) in our regular taxable account. And we put $300 in a money market fund with our bank.

The money market is now at about $7000, and we realize we don't have a good option to invest that money. We don't want to have the money sit in a money market account. Certainly not for 16 more years. Neither do I feel comfortable putting all of it in 529. Hence, I am looking for an option that (1) provides growth opportunities, (2) has low tax impact, and (3) has some mechanisms built in for age-appropriate auto-(re)balance.

In the last show, Chris mentioned tax-managed mutual funds as an option for semi-long term tax efficient investment. I looked at Vanguard's tax-managed funds. They all cost quite a bit to start, $10,000. So this doesn't seem to be a valid option.

What other options are available? I suppose that I can buy ETFs at a discount on-line brokerage as a way to boost tax efficiency and hold diversified investment stocks. I am not sure if, given the amount of dollars we are talking about here, ETF would be a good choice, e.g. the amount of saving on tax efficiency would offset other shortcomings of ETFs. I have a hard time thinking about or comparing ETFs with index funds. In addition, I will have to do age-appropriate asset re-allocation myself with the ETF funds. Because that would take time and discipline, it might not be an attractive option 10 or 15 years from now.

Another thought is to buy a Vanguard target retirement fund that sets my son's college entrance year as the retirement target year, say 2020. With this, I at least can have stochastic asset reallocation as a means to reduce portfolio risks. But I have no idea how tax efficient that fund is. And it probably is not. Thanks. Key, Cary, NC

Answer: Your question is extremely thoughtful, and just reading how you're thinking through the various options and trade-offs might help someone else decide what to do.

Fact is, I like what you're doing: a mix of a 529 plan, index funds and a money market fund. I hope that the index funds and money market fund are in your name so that if your son gets scholarship money, you can tap the savings for your retirement. I prefer the index mutual funds over ETFs because the former are ideal for adding money on a monthly or quarterly basis without paying the brokerage fees or commissions. So I would take some of the money market fund money and put it to work in the index funds.

One other thought: You could buy some I-bonds to add into the mix. The fixed 30-year rate of interest on the inflation-protected savings bond is currently 1.2% per year (plus the actual rate of inflation). But it will almost certainly fall when the rate is reset on May 1. The limit per person is $5,000 in electronic form at www.treasurydirect.gov and another $5,000 per person in paper form at banks. Still, you get a guarantee that a dollar saved today will be worth a dollar plus interest 16 years from now when your child goes to college. And the money compounds tax-deferred until you cash it in.

04/22/08 by Chris Farrell

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Coverdell College Savings

Question: I have 2 Coverdell IRA's for my 2 children, to which I contribute what I can. I've heard that the program is set to expire in 2010. 1) Is this true? 2) Does this mean I have to get the money out and close these accounts before 2010? My children are both under 10 years old. Brian, Ann Arbor, MI

Answer: You're right that a number of the college savings attractions attached to the Coverdell will end in 2010. I'm not really sure why Congress improved the 529 college savings plan in 2006 but left the Coverdell vulnerable. But it did. For instance, the Pension Protection Act of 2006 made withdrawals from 529s permanently tax free when the money goes toward qualified educational expenses, like tuition. What's more, the sums invested in 529 plans aren't considered a student asset in the financial aid formula calculation.

In sharp contrast, the Coverdell didn't get legislative protection. No, upgrade passed in 2001, such as raising the contribution limit from $500 to $2,000 and allowing tax-free withdrawals for K-12 expenses, are still slated to expire in 2010. The Coverdell will be then much less attractive choice for college savings. For instance, right now you can make tax-free withdrawals from a Coverdell to pay for college and still take advantage of the Hope or the Lifetime Learning credit. After 2010, you'll be forced to decide which benefit to take, the tax free withdrawal or the credit.

What to do? If you like your Coverdell accounts you can continue to make contributions into them. If the Coverdell bells-and-whistles do expire, you can always roll the money over into a 529. (It's a tax-free rollover.) You can gamble that Congress will get rid of the 2010 sunset date. Or you can open up a 529 plan for your children. No matter which choice you make, your savings will compound tax-deferred and your children will benefit from your thrift. I just wish Congress would stop all this nonsense about sunset provisions. It makes savings more complicated than it should be.

04/29/08 by Chris Farrell

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Co-sign for Law School?

Question: I am 58 years old, a self-supporting teacher, and anxious about my retirement savings. My son at the age of 29 has decided to go to law school, and asked if I would co-sign $14,000 of his student loan package. The thought of having my name attached to a debt of any kind is distressing. Am I being unreasonable?... And what about the immediate liability? Does the $14,000 go on my credit report until it's paid? Are there any liabilities to my credit, just for being a co-signer? Thanks for your advice. This is a heart-rending situation. I don't think I can say no, but the thought of being a co-signer at my age makes me VERY nervous! Carolyn. Carlsbad, CA.

Answer: I understand the desire to help out your son financially. But I would not co-sign the loan. You're right to worry that the risk is too great, especially with retirement looming. Put it this way: I assume your son has done the calculations that a law degree will pay off over time in higher earnings and better career prospects. Assuming that is the case, the debt burden is well worth taking. Time is on his side, and he should absorb the risk of something going wrong. You shouldn't be on the hook financially.

To be sure, one advantage of you cosigning the loan is that he will probably get a better rate on the loan. Again, it's really a question of whether the investment in a law degree will pay for itself. You could always make a small private loan to him on your home to help him out with an understanding that he'll pay you back later on.

05/20/08 by Chris Farrell

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Heloc vs. Student Loans

Question: Is it better to use money remaining in our HELOC, money in our savings account or to take out student loans to pay for our daughter's college tuition ($49,000.00)? Linda, Los Angeles, CA.

Answer: We've been getting many more questions about equity loans recently. When it comes to paying for college my approach is a mix of student loans, work-study, and parental savings.

I am wary of parents taking out home equity loans for college. The reason is that for most of us one of the best financial moves we can make is to enter our retirement years without a mortgage (or at least a minimal mortgage). This way the home is a critical part of our financial safety net.

In sharp contrast, your daughter has a lifetime of earnings ahead of her. It makes more sense for her to borrow for her education, and for you to help her out along the way (perhaps even after she's graduated) so that she doesn't end up with too much debt.

06/03/08 by Chris Farrell

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529 Plans

Question: My husband and I had our first child in February. Our budget has us paying off our student loans and credit card debt in the next 16 months. We'd like to put the money we currently spend on our student loans ($500 a month) and place it in a 529 fund for our daughter once both debts are paid off. I've seen a lot references to 529s, but was wondering if you could recommend some sources that provided guidance on how we can review the various states' 529 plans and their pros and cons. By the way, we plan on spending the money we've budgeted monthly on paying off the credit card debt to restore our savings as I stayed home on unpaid FMLA to care for our daughter after utilizing all my paid sick leave from work. We were able to finance the unpaid leave from our savings, which also depleted it (but was well worth it). Jennifer, Spring, TX

Answer: What a good use of savings. You had the money to do something important for your family. Bravo. The reason I'm posting this question is that your approach toward debt-and-savings is one I highly recommend: Pay down the debt, and when it's extinguished keep on setting aside the same amount of money into savings. It's a sound strategy for replenishing and building up savings.

The best resource for learning more about 529 college savings plans is at www.savingforcollege.com. It offers a good overview section for free. You will have to pay a modest price to get access to the detailed information. Check it out.

06/09/08 by Chris Farrell

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July 1, 2008 and Student Loans

Question: I'd like to first start off by saying I love show and could listen to it for 3 hours a day if it were on and I had the time. Honestly, how can someone like Chris know so much about such a wide range of financial topics? I've heard a lot recently about the July 1st deadline to consolidate students loans to a very, very low rate and was wondering: 1) What personal information do I need to gather? and 2) What website should I go to.

I usually am at work when the show is on, so I only get to listen to bits and pieces, but an e-mail or any response would be greatly appreciated. Thank you! Wade. Duluth,MN

Answer: I'm glad you enjoy the show. On the student loan front, there's no need to rush. However, anyone with variable rate student loans should mark July 1 on their calendar. If you consolidate after that date you can lock in interest rates 3 percentage points less than the current 7.22%. That's a huge savings over the life of a loan. So, if you're thinking of consolidating, wait. The student loan consolidation market has shrunk with the credit crunch. Hopefully, it will open up again soon.

What's more, on July 1 the clock starts ticking on the new federal program that forgives remaining federal student loan debt after 10 years if you make all your payments on time and work for the government, non-profit, or other qualifying job.

A nice summary of what will happen on July I, 2008 is on the website Project on Student Debt at www.projectonstudentdebt.org. The specific page is http://projectonstudentdebt.org/july1-2008.vp.html.

06/27/08 by Chris Farrell

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Co-Signing for Sister

Question: I have a sister who is currently applying for private student loans. She has no co-signer and is therefore subject to higher interest rates and is finding it more difficult to be approved for a loan. I've thought about offering to be her co-signer, but first I'd like to make sure I am fully aware of the consequences of being a co-signer. Would it affect my credit or ability to get other types of loans in the future? She needs to borrow around $16,000 for the entire year. I personally have nearly $40,000 in student loan debt myself. I'm 24 and have a stable income. I'm also very confident that she would pay the loan back herself. Thanks for your help! Any advice would be appreciated. Elizabeth. Eagan, MN.

Answer: Put it this way: When you co-sign you are taking on the responsibility to pay off the loan if your sister can't. Period. It can affect your credit score and your ability to take out another loan. My personal preference is for family members not to help each other out financially by cosigning. It's a legal document that carries a serious obligation, especially for someone like you who is just starting their career. If she does need your financial help and support, it's much better to lend her some money privately in a pinch. The two of you just need to have an understanding of what that means-as sisters--without involving legal documents, credit reporting bureaus, credit scores and the like.

07/10/08 by Chris Farrell

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529 Plans and Financial Aid

Question: I have read in your archives that money in 529 plans is considered a parental asset not a student asset in the college aid financial aid calculations. However, I have encountered several companies here who say that (1) 529 plans will be counted as student assets and (2) that they are a bad place to put college money as it lets the colleges know exactly how much money the child has and therefore any offer will be less. They even promote "repositioning" these assets to hide them. Any comments? Thanks. Annette. Los Angeles, CA.

Answer: My main reaction: Don't do business with these companies. First, and most importantly, I'm against the whole business of hiding assets when it comes to financial aid. Period.

Secondly, these companies are wrong when they say 529 college savings accounts will be counted as a student asset on the main financial aid form, FAFSA. (Private colleges can do what they want, but most of them follow the FAFSA model with a few tweaks.)

Third, saving for college in 529 is financially smart: The savings compounds tax free, and withdrawals are tax free when used to pay for qualified educational expenses.

Fourth, experience suggests that it's easier for parents and their students to contemplate a wide range of schools when there are savings to tap into.

07/24/08 by Chris Farrell

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529 for Adults?

Question: I'm curious to hear your opinion--is a 529 plan a good idea for adults who are planning on graduate school?

I'm planning to enroll in a PhD program sometime in the next 5-10 years. Is a 529 a good idea? Bridget. Sioux Falls, ND

Answer. We don't hear enough about adults planning on college, which is why I like your question. The answer is that a 529 plan can make sense for someone like you. Students of all ages can save in a 529 and tap into it for undergraduate and graduate degrees, paying for everything from tuition to textbooks to computers. One drawback for adults is that you're giving up flexibility with the money. It has to go for your graduate degree (or you can transfer it to a family member). Otherwise, you'll pay taxes plus a penalty if you end up using the money for any reason other than education.

07/28/08 by Chris Farrell

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Saving for College

Question: My husband and I have three sons who are five years old and younger. We have saved $15,000 for them so far in an interest advantage account. After the recent bank failures, my husband and I looked into these accounts and found out that they are not FDIC insured. Our goal is to save for their college education or training. Could you please give us some suggestions on what to do with the money that would give us a good return and does not have much risk? Thank you for your time and we look forward to hearing from you. Janet, Henderson NV.

Answer: You're right that an interest advantage account isn't FDIC insured. It's essentially a money market fund. I'm aware of two interest advantage funds, one run by Ford and the other by GE.

How about putting the money into a 529 plan for each of your children? Of course, a 529 plan isn't FDIC insured either. But you have the safety of a well diversified portfolio. The investment compounds tax free. The gains are tax free too if the money is withdrawn to pay for qualified educational expenses. The investment gets favorable treatment in the financial aid formula. It's a tough combination to beat. You can learn more about 529 plans by searching the Getting Personal questions and answers. A good resource for research is www.savingforcollege.com. The personal finance magazine Kiplinger's (www.kiplinger.com) also has good information.

A 529 plan is my number one college savings option at the moment. For those interested in putting their money into a FDIC insured account the College Savings Bank may be worth investigating. It's at www.collegesavings.com. The CollegeSure certificate of deposit is a variable rate CD indexed to college costs. Principal and interest are FDIC-insured to at least $100,000 per depositor.

08/13/08 by Chris Farrell

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A Merger

Question: I own about 400 shares of Anheuser Busch common stock. I have been accumulating the stock slowly since 1976 mostly through a DRIP program. So my tax basis is relatively low. A company, I think it is "In Bev" is offering to buy out Anheuser Busch stock holders for about $70 per share. I would like to avoid paying taxes on the gain by putting the proceeds from the sale into some vehicle where the principle and interest will be available for my 8-ear-old child in the future, say college or high school expenses. Do you have any suggestions? Thank you. Brian, Brooklyn, NY

Answer: Yes, it's the Belgium multinational InBev that is buying Busch. You won the stock-owners lottery. . The price tag for your good fortune is that Uncle Sam will take part of your gain. Most of the tax bite should be long-term capital gains, which is currently at 15%. One time-honored method of limiting the tax take is to comb through your portfolio and see if there are any stocks or mutual fund you'd like to get rid of at a loss. You can use a capital loss to offset a capital gain. You may be able to avoid paying capital gains altogether. The long-term capital gains rate for investors in the 10% and 15% income tax bracket will drop to zero between 2008 and 2010. The same zero rate holds for dividends.

My tax reactions are just quick ideas. It is well worth your while to work with a professional accountant to delve into the details of your portfolio to see how to best handle the gain.

In terms of taking the gain and saving for your 8 year olds college education, I'd vote for putting at least some money into a 529 college savings plan. The contribution must be in cash, and it's made with after-tax dollars. But the money compounds free of taxes. The gain is also tax free when the money is withdrawn to pay for qualified educational expenses. A 529 plan is treated favorably when it comes to the basic financial aid formula.

08/21/08 by Chris Farrell

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Borrow to Fund 529s?

Question: My wife and I have no debt except for $23,000 from a home-equity line. This year, she took some time off, reducing our income and meaning that we might not be able to save into our 529s for two sons, ages 6 and 4. (We will save $36,000 for retirement this year.)

My question: Should I borrow $10,000 from our Home Equity line to fund these 529s? My argument is that I immediately get the NYState 6% tax reduction for that whole $10,000 ($600), that the Home Equity interest rate is small (4.75%) and deductible so effectively even smaller (3.5%), and that there is a lot of upside with the market at about 11,500. My wife's argument is that I am completely nuts. Thank you for your (gentle) reply. David, Amherst, NY.

Answer: No, I'm not going to say you're nuts. And you can make the numbers work if you use the stocks market's average annual rate of return of some 7% (after taking inflation into account). Problem is, the flaw with using averages is that Lake Erie never freezes and stock market returns don't fluctuate.

We get variations of this question all the time. What's unusual about your query is the timing. Usually people want to borrow and put the money into whatever asset is flourishing at the time--Internet stocks, residential real estate, and so on. Right now, it seems that just about everything is weak: The economy, the job market, homes, stocks, even commodities.

Leverage is risky. Borrowing to invest in stocks and bonds can backfire badly since you need to make those interest and principal payments even if the assets you've bet on cratered. So I wouldn't do it.

To put it somewhat differently, I don't think the potential rewards justify the risk. It's wonderful that you are saving for your children's college education. But they'll still be able to go to college even if you don't save in their 529s for a year or two. Maybe they'll have to borrow a bit more to pay for college. But that's the biggest downside I can see.

08/25/08 by Chris Farrell

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Student loans

Question: No one has yet commented on how the credit crisis is going to affect the availability of college loans. Likely, since it's still early in the educational year, no problems have been noticed...but what about later? Drew, Carlisle PA

Answer: The credit crunch is having a dramatic impact on the student loan market, although it does appear that most students are getting the money they need at the moment. Companies that lent to students relied heavily on securitizing those loans and selling them into the global capital markets. That business is largely shut down with the credit crunch. Sallie Mae and other student loan companies are struggling. Many financial institutions have stopped making private student loans or consolidating student loans. Compounding the financial pressures on lenders is a recent law that limits federal subsidies to them. Parents are also feeling the pressure since it's estimated that about a quarter of tuition costs were paid with home equity loans, and that market is drying up too.

I think the Department of Education has been a government backwater during the credit crisis. Still, it has enacted several initiatives to bolster the market. Most recently, it said it will support the market by buying up to $6.5 billion in federally guaranteed loans from the 2007-2008 academic year. The Dept. of Ed. is focusing on shoring up the Federal Family Education Loan Program, which accounts for most of the loans banks and other financial institutions make to students. The government also makes loans directly to students. (I expect that this latter program will expand under the new Administration.) A number of universities are dipping into their funds to make loans available.

So far, it looks as if the stopgap measures are mostly working. But there are genuine concerns going forward. The Dept. of Ed is working on a bigger program announced Nov. 8 to buy up more loans, but it will be awhile before it is up and running. It may not be enough, either.

More fundamentally, I think that the student loan boom has gone bust. Government policy, as well as colleges and universities, have come to rely too much on student loans. It's anecdotal, but I find it fascinating that - judging from the emails we get at Marketplace Money - student loans have replaced credit cards as the main debt worry of young adults. It's also sinking in that the student loan default rate is much higher than the 4% to 5% level the Department of Education has officially announced for years. For example, reaching back into the 1990s and following student experience over the subsequent years, students with loans totaling $15,000 or more had nearly triple the default rate of those with loans of $5,000 or less--19% versus 7%, according to researcher Erin Dillon of Education Sector, an independent think tank based in Washington D.C.

Finally, if you look at the wages of college graduates in the 2000s they're either flat or down, after adjusting for inflation, while the real cost of student borrowing has gone up. The college market needs to change: Too much debt, a high default rate, and low wages at graduation don't add up.

11/26/08 by Chris Farrell

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A break with student loans?

Question: I was doing 'ok' paying down credit card debt until HSBC raised everyone's APR 10%, mine went from 14% to 24%, now I am really struggling. My Student Loan payments are $600.00 a month. Is there any word on the possibility of a hiatus on making Student Loan payments for a few months, or better yet, a year for those of us in trouble? It would really help! Patricia, Washington D.C.

Answer: Arrgghhh. The still all-too-common tactic by banks hiking their credit card interest rates in this environment burns me. It's a bad move at a time when the taxpayer is bailing out the financial system.

That said, at the moment I'm not aware of any new legislative initiatives (with credibility and momentum) that aims at giving financial breathing room to anyone paying back their student loans. That could change, of course, since much of the $825 billion fiscal stimulus package remains to be negotiated before the legislation ends up on the President's desk.

Still, according to a recent story in Inside Higher Ed, it appears tens of billions of dollars are heading toward colleges and universities.

The initiatives highlighted by Inside Higher Ed would help out a number of students and their families. For instance, there's a proposed nearly $16 billion increase in Pell Grant funding, boosting the maximum Pell Grant by $500 to $5,350; an additional $490 million for federal work study funds; almost $13 billion to replace the Hope tax credit with a new tax credit worth up to $2,500 a year; and a $2,000 increase in federal limits on unsubsidized loans.

Two quick thoughts: Make sure to take advantage of all the tax deductions and tax credits you qualify for. Hopefully, you'll get a refund that you can put toward reducing the credit card debt. Similarly, you might get additional tax payments depending on what becomes law over the next few weeks.

Secondly, if toughing it out isn't working and you really need to reduce your monthly debt payments you could look into changing your student loan repayment options. There is a financial flexibility built into federal student loans. (The same can't be said for private student loans.) However, all the different ways to lower your monthly bill today come with a price: You end up increasing the overall cost of the loan.That's why if you or anyone else goes this route I always recommend getting more aggressive about paying down the loan later on when times are better. There is no prepayment penalty with student loans.

The main options for lowering the monthly payment are the Graduated Repayment Plan (payments start out low and increase over time), the Extended Repayment Plan (stretch out the payments), an Income-Based Repayment Plan (your monthly payment rises and falls with your income), the Income Contingent repayment plan (the payment can't exceed 20% of discretionary income), and the Income Sensitive plan (monthly payments are a percent of gross monthly income).

You can learn more about these loan options at Finaid at www.finaid.org/loans/repayment.phtml. If you are in more dire straits you could also qualify for student loan forbearance or deferment. Finaid also offers up good information on those two options.

Good luck.

01/26/09 by Chris Farrell

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Consolidate loans to mortgage

Question: Please help... Would it be a good or bad decision to put a non-consolidated Parent Plus Loan into a home refinance? The refinance rate is 4.5 and the student loan is 7.9 (!) I have two other consolidated loans at 3.25 and another at 5.875. I'm currently over the limit (2x) of interest I can deduct, so if included it, the interest it would be deductable, but does it make sense to increase my mortgage by so much (an additional 32K on a 156K mortgage? And I will have to pay an additional .25 point to do the cash out. Will the Plus Loan interest rate be reduced in July? Would it make sense to wait and consolidate? My refinance will settle before I know the next rate. Will the deductable student loan interest rate be raised? I have a line of credit rate currently at 2.5, but they will average 3 years interest to do a fixed loan, so that w on't help now. I would rather keep it separate, but am temped by the 4.5 rate. I want to make the best short and long term decision.... Thanks in advance for considering my question. Mary, Garrett Park, MD

Answer: I want to address the core of your question. I believe one reason why so many middle-income homeowners got into financial trouble in recent years is that they consolidated their debts into first and second mortgages. Yes, the interest payments are tax deductible. But I don't think the tax deduction is worth the extra risk.

For instance, it always upset me when financial advisors would recommend consolidating credit card debt into a mortgage. That's crazy. I feel the same way about student loans. There is financial flexibility with Parent Plus loans, such as a graduated payment plan, income sensitive payment plan, and an extended payment plan. (Of course, the price for taking advantage of these options is the overall cost of the loan goes up.) If you pay off the loan by rolling it into your mortgage you'll lose that flexibility, and increase the risk of losing your home if you have a job or income setback.

02/12/09 by Chris Farrell

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Keep funding 529 for daughters?

Question: Greetings Tess and Chris, I love the show. I'm a military officer, but since I graduated from a service academy, I was never eligible for education benefits through the old GI Bill. Apparently, with the new one, I now have benefits and can pass them to my wife or children. We have 2 girls, 6 and 4. We've completed a state sponsored pre-paid college program for the elder, and now we add $100/month to a 529 for her. We have $7500 in a 529 for the younger, and add $250/month to that account. So my question is: Do I now have overlapping benefits that I won't be able to use fully? If so, should I adjust our college savings rates to prevent having more money than we need allocated solely to higher education for our girls? As I tell my wife, if they go to a service academy, they won't need any of it! Micah, Kodiak, AK

Answer: Well, if they do go to a service academy maybe you and your wife can tap the 529 savings plan for your own education! It's great that you've saved for them. The bottom line is that your daughters will have a lot of choice when it comes to college. However, I would probably stop making contributions to the 529 plans for now. (I'd keep saving the money but in your name. It never hurts to add to savings.) The details and rules about transferring education benefits in the new G.I. Bill haven't been finalized. When they are, you'll be able to take a look at what you've saved, the value of the benefits from the military, and then make some adjustments to set it up so there will be few out-of-pocket costs when your daughters do go to college.

One reason why I don't think you've wasted any money is the cost of college. The most recent data has tuition and fees at an in-state public four-year college at $6,585. But the average cost including room and board is $14,333. And that's assuming they go to an in-state public university. The advantage of what you've done, coupled with the military education benefit, is that it will also bring the price of a private college within realistic reach if that's what they and you want a decade from now.

02/19/09 by Chris Farrell

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How to reduce student-loan payments?

Question: My husband has significant private student loans, about $100K, through Sallie Mae with above market interest rates. The current monthly charge is more than I can afford. What are my options to reduce the amount owed or the payment amount? I am on partial disability and my husband recently joined the military. Many thanks, Tanisha, Orlando, FL

Answer: The first thing I would do is to take advantage of the free legal assistance you can get at offices located on almost every military base, ship and installation. The military lawyers will have dealt with situations like yours many times over. According to www.military.com (a terrific resource on military benefits), military lawyers can do everything from negotiating with another party to drafting wills to personal finance advice. Unfortunately, there is less financial flexibility with private loans compared to federally-sponsored loans. Still, since your husband is on active duty he may qualify for a 36 month deferment from Sallie Mae. The Servicemembers Civil Relief Act offers active duty personnel debt protections, too. If his military service affects his ability to pay off debts such as credit cards, mortgage and some student loans the rate on the loan can be capped at 6%. The reduction is only for the time of active duty, but any interest above 6% is forgiven. This is for debt taken on before active duty. Again, the military lawyers will be able to walk you through the options available to you.

by Chris Farrell

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Student loans and fiscal stimulus

Question: Is there any chance of bailout money for student loan borrowers? I assume that if there is any bailout money aimed at student loans, it will be given to the lenders and not to the borrowers, but if individual homeowners are eligible for bailouts, why not individual students? A lot of students imprudently ran up too much debt, just like home buyers. : Eric, San Diego, CA

Answer: It's a good question, and we've gotten a number of similar queries from listeners and readers. The bottom line answer is that indebted graduates with a college sheepskin aren't getting help. The stimulus package does direct money toward making college more affordable, especially for students from lower income families. Higher education isn't going empty-handed, either, with money available for investments like university research and university infrastructure. But nothing was targeted at easing the student loan debt burden of college graduates. My guess is that policymakers--if they thought about it at all--decided the tax breaks will give graduates extra money this year and, if it makes sense, they can direct the money toward debt payments.

02/24/09 by Chris Farrell

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A home? a Master's? both?

Question: My son wants to buy a home and get his masters degree in the next five years. He is single and in his early 30s. He has excellent credit, very little debt, earns about $80K gross a year, and has cash for a 20% down payment. He has been with his current job for less than two years and is going to school part-time. If he gets laid off in this economy, he will have trouble paying his mortgage but it will put him back into school full-time and get him through his degree quicker. He is making a career change with the Master's degree program, which will take 2 years if full time and will leave him with $20K in student loans. When he graduates, he will have to look for a job in another field with a starting salary that is lower than his current job.

What suggestions do you have for him in terms of timing of his home purchase and education vis-à-vis the economy and his personal circumstances? I had suggested that he postpone his career change until the economy rebounds, but these days you can't convince kids to hold down unsatisfying jobs just for the sake of income and financial stability. Thank you. Ellie, Fitchburg, MA

Answer: Your son is making a big investment in his new career. He knows he'll probably graduate with student loans to repay, and he'll end up with a lower paying job once he has his Master's in hand. The return on investment comes from entry into a career he will enjoy and higher pay as he gains experience in his new field. He's making a big investment in his future.

I would advise against making an additional investment in a home. Sure, home prices look increasingly attractive. But he will be creating a high-risk personal balance sheet if he goes into debt to buy a home and takes on debt to get an advanced degree. He might come out okay if everything goes well. But the unexpected always happens--another bear market? a spike in interest rates?--sometimes on the upside and sometimes on the downside. He'll be at risk with all that debt if it's the latter.

He can always buy a home when he's embarked on his new career. Instead of using his savings for a 20% down payment, I'd use the money to reduce or even eliminate any student loans. He could also tap into that savings to help fund his career shift once he reenters the job market. I'd encourage him to invest in his career now, and buy a home later on.

04/08/09 by Chris Farrell

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The education IRA

Question: My wife and I had our first baby in January of 2009 and are looking into saving for her education. I have heard a lot about 529 plans but very little about Coverdell accounts. So far I have learned that both 529s and Coverdell's allow money to grow and be withdrawn to pay for the education of the beneficiary tax-free. While the Coverdell does have a $2k/year contribution limit, contributions are also tax deductible while 529 contributions are not (at least in California). Why haven't I heard more about Coverdell accounts? Is there a reason why I would not max-out my Coverdell contribution and then put additional money into a 529? My wife and I make a combined taxable income of about $150k. Hans, Sherman Oaks, CA

Answer: The Coverdell Education Savings Account is one of the least understood ways to save for college. It used to be known as the Education IRA. In essence, it acts much like a Roth-IRA. You contribute up to a maximum of $2,000 in after-tax dollars--contributions are not tax-deductible--at a financial institution of your choice. There income phase outs and limits to the Coverdell. Joint filers with $190,000 or less in modified adjusted gross income qualify for the full $2,000 contribution. The income limit for single filers is $95,000 for single filers. For joint filers the contribution amounts is reduced for modified adjusted gross income between $190,000 and $220,000--after that you're out of luck. The comparable figures for single filers are $95,000 and $110,000.

The money compounds tax free. If it is used to pay for qualified educational expenses withdrawals are tax free too. Unlike a 529 plan, the account can be tapped tax-free to cover qualified education expenses at primary and secondary schools as well college.
Here's the rub: The annual contribution limit is $2,000 until 2010, when the figure drops to $500. A number of other college savings attractions attached to the Coverdell will end that year, too. I'm not sure why Congress liberalized the rules surrounding the 529 college savings plan in 2006 but left the Coverdell vulnerable to changes in its treatment in 2010. After 2010, the Coverdell will be a much less attractive way to save for college compared to the 529. That's why I favor the 529 plan.

But there is no reason why you couldn't contribute to the Coverdale to the maximum for now, in addition opening up a 529 plan. You can learn much more about the details of the Coverdell at savingforcollege.com.

04/20/09 by Chris Farrell

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A college savings plan?

Question: We are in our 30's with three kids ages 7 and under. We live simply and have been able to get by on our income around $24,000 per year, plus our tax return which is usually several thousand. Though this seems like pennies compared to what others mention saving and investing, we have over the last 7 or so years managed to save over $10,000. We now find ourselves in a situation where we don't need to buy a house (which is what we originally thought we were saving for) but feel like that $10,000 should be put to use for us somehow. We like the idea of starting 529 plans for the kids' college funds. But we have nothing in the form of potential retirement. Should we invest it in some other way? Or, should we just keep it in our savings account, which is what we have done in the past. Often we have had to dip into several thousand a year between car trouble, and slim employment income. Kari, Eau Claire, WI

Answer: You're terrific savers. Congratulations. I understand your desire to set money aside for your children's college education. But I wouldn't if I were you. Several years ago I interviewed the head of admissions at the University of California, Berkeley. He made several points that have stuck with me. When you have a slim employment income and have to worry about keeping the car running you shouldn't set money aside for college. Instead, focus on making sure that your kids get a good education, one that prepares them for college. But with your income and three kids there will be plenty of money available from the federal government, state government and colleges to help defray the cost of college.

I'd rather you continued to save for a rainy day and for your retirement. You can accomplish both with a Roth IRA. I've written a lot about the Roth on this blog. In essence, a Roth is a retirement savings plan funded with after-tax dollars. When you withdraw the money during retirement it's free of taxes. That's right, Uncle Sam doesn't tax Roth savings. Here's the thing: You can take out your contributions at any time without paying a penalty or taxes. You just can't withdraw any gains (you would pay a penalty and income tax on the gain if you take it out early).

So, a Roth is both a pot of emergency savings and a retirement savings plan. This is a nice article from Kiplinger's that goes into more detail about a Roth.

05/27/09 by Chris Farrell

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Save more or attack student loans

Question: I am trying to balance saving enough money in case I lose my job and paying down my current (and increasing) student loan debt. I work full time and am a part-time law school student. I have pre-existing school loan debt from another graduate degree (about $45,000). Now, I'm accruing more by attending law school. The pre-existing loans are deferred, but I could still make payments since I'm working. I am not sure how to balance making sure I have enough savings and paying off the debt. Right now, I have a solid 10 months of expenses in savings (not counting any of my retirement savings). Should I stop worrying about the savings and start paying down the school loans again? Rebecca, Hoboken, NJ

Answer: As you well know, the cost of living in the New York City area is expensive. It's impressive that you've accumulated a solid 10 months in savings. It's a decent financial cushion for anyone. It's a judgment call, but a key for answering this question is this: Is your job is really at risk or are you just feeling the general unease we all have about our jobs during the economic downturn. Assuming that you are reasonably secure in your job I would start paying down the student loans again. And then you can get even more aggressive when you get a job as a lawyer.

06/22/09 by Chris Farrell

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Parent PLUS loans

Question: I took out a Parent Plus loan with Sallie Mae when my son started school. He's finished now. Can I get the loan changed to his name? Thanks. Mary, Breese, IL

Answer: No, Parent PLUS loans are the financial responsibility of the parents, not the student. You could ask your son to make the payments for you on the PLUS loan. But if he misses payments and falls behind you are still responsible.

07/01/09 by Chris Farrell

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529s and student loans

Question: I have a 529 fund for my daughter. she graduated in May. In the process of her going to school we went ahead and took out school loans. There is enough money in the 529 fund to pay the loans off. It seems to me since the funds are going to pay off an education fund there should not be any tax issues but the fund management company says paying of the school loans is not a an "approved" use of the funds. They are right that is is not "listed" on the approved list but it is paying off college loans by definition the loan was for school and went toward tuition etc. I have checked with several accountants no one seems to give me a straight answer. Eric, Grand Island, NE

Answer: I'm taking your question because it highlights a common pitfall. Student loans are not listed as one of the Qualified Higher Education Expenses for a tax free withdrawal from a 529 college savings plan. The list usually includes tuition, fees, books, and supplies and equipment needed to attend a college. For instance, a personal computer is considered a qualified expense. Room and board counts for students who are enrolled at least half-time, although there are some restrictions. Student loans aren't on the list. I don't make up the rules.

Two quick thoughts: Your daughter can use the money for graduate school if she has plans to attend one in the future. The account owner can also change the beneficiary of the plan. The restriction is that the new beneficiary must be a member of the family of the old beneficiary. Here is how the IRS defines family: The beneficiary's family includes the beneficiary's spouse and the following other relatives: Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them; brother, sister, stepbrother, or stepsister; father or mother or ancestor of either; stepfather or stepmother; son or daughter of a brother or sister; brother or sister of father or mother; son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; the spouse of any individual listed above; and first cousin.

I've recommended these web site before, but two good sources of information on 529s are savingforcollege.com and finaid.org.

08/10/09 by Chris Farrell

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College money for nieces

Question: My husband and I are looking for ways to help our two nieces (currently ages 1 and 3, and in two different families) with future college expenses. We'd like to contribute $1000/year to each of them and we're wondering what the best way of doing this is. Should we have a trust set up for each of them? Or is there a better way? Thanks! Valerie, Minneapolis, MN

Answer: That's a wonderful idea. But there is no reason to go the trust route. The easiest thing to do is find out whether the parents have established a 529 college savings plan. If they have, put the money every year into the account. Contributions into the 529 are with after-tax dollars. The earnings grows tax-deferred and withdrawals are free of federal taxes so long as the money is used for qualified educational expenses. In a majority of states withdrawals also escape state taxes. If they haven't set one up I would encourage them to do so. They can open up an account in most states for about $25 or so. A good source of information is savingforcollege.com.

09/08/09 by Chris Farrell

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Relief on student loans

Question: My son was recently told by another graduate that there is a program that limits the amount of monthly payments for student loans. Are you aware of this and is there a place to call? Mary, St. Clairsville, OH

Answer: Sounds like your son needs some financial relief. There is genuine financial flexibility built into federal student loans. (The same can't be said for private student loans. They are really high-cost installment loans. The term "student loan" is a misnomer.) However, all the various ways of lowering his monthly student loan bill come with a price: He'll increase the overall cost of the loan over time. Still, he'll get a break now and, since there is no pre-payment penalty with student loans, he can always accelerate his payments if his money circumstances improve.

The main options for lowering the payment are the 1) Graduated Repayment Plan (payments start out low and increase over time); 2) the Extended Repayment Plan (stretch out the payments); 3) an Income-Based Repayment Plan (your monthly payment rises and falls with your income); 4) the Income Contingent repayment plan (the payment can't exceed 20% of discretionary income); and 5) the Income Sensitive plan (monthly payments are a percent of gross monthly income).

Whew--that's a really quick tour. Obviously, he'll need to look at these options in more detail. He can learn about these loan options at Finaid at finaid.org. The U.S. Department of Education at ed.gov also offers good loan information.

I don't know if this applies to your son, but federal and state governments will forgive loans or make loan payments in certain circumstances. The military is one example. So is teaching in inner city schools. A new program has the U.S. government paying the remaining interest and principal on federally backed student loans for employees that have worked for the government for 10 years. You must be in good standing with your student loans, too. The benefit extends to a lengthy list of other "public service" jobs, including law enforcement, public defender, nursing, and child care. It's a way to attract young talent to the public sector and public service jobs. If Hollywood remakes the 1967 classic The Graduate, the advice to Benjamin might be "public service" instead of "plastics."

10/07/09 by Chris Farrell

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