My 18-year-old son will be going to college in a few weeks. I have followed your advice from a recent column and I have done medical and durable powers of attorney for him. I also checked with my homeowner’s insurance agent to make sure he is covered, which he is. In addition, I did have a few conversations with him about money and overspending. My question deals with paying for his college. I figure with room and board, tuition and books, along with miscellaneous expenses, it will cost me about $25,000 a year. What I would like your help in is choosing where for the first year I should get the money from. My options are to first get a home equity loan. My house is owned free and clear and I’ve already been approved for a home equity loan. My second option is to take a loan from my 401(k) Plan. The third option is to take the money from my portfolio. I am curious as to what option I should use.
I think it is great that you have talked to your homeowner’s insurance agent and have done medical and durable power of attorneys for your son. Particularly in cases of emergency these items can be invaluable to you. In addition, I love the fact that you have had the conversation with your son about personal finance. All too often kids go to college without any financial knowledge and it causes problems. Therefore, congratulations.
In reviewing your funding options, the one option I would not consider at this point in time is borrowing from your 401(k) Plan. Your 401(k) Plan is for your retirement and I think those monies are sacred. When you borrow against the 401(k) Plan there also can be some unintended consequences. For example, many companies will not allow you to continue to invest in your 401(k) if you have an outstanding loan. As a result, you could lose out on valuable company matches. In addition, you could run into difficulty if you decide to leave your current place of employment. Because of these reasons, and that there are other options available, I would tell you that the 401(k) loan is the least favorable option.
Between using a home equity loan and selling some of your investments, at this point in time I would probably lean toward the home equity loan. My reasoning is that interest rates are low and home equity loans are tax deductible. Therefore, after taxes, the loan would cost you about three percent which is inexpensive money.
Of course, the one risk of using a home equity loan is that if interest rates rise in the near future, your interest on the loan would also increase. However, considering the amount that you are borrowing, I do not believe that this is a material issue.
By using the home equity loan you are also covering your backside. If interest rates do for some reason skyrocket (which I doubt), you can always choose to sell some of your investments to pay off the home equity loan. Therefore, you’re giving yourself some flexibility. I believe in this ever-crazy world which we live in, having flexibility is important.
For those of you who have children getting ready to go to college, it is important to remember that since they’re 18 years of age they are legal adults and thus, as the parent, you don’t have as many rights as you did when they were minors. Therefore, it is important to obtain the necessary legal documents to protect you and your child in cases of an emergency. Hopefully, you will never need to use a medical or durable power of attorney for your child; however, these documents can be invaluable to you in times of a family crisis. Therefore, my recommendation is for all parents with children going to college is to obtain these documents. You don’t have to pay anyone to do this; you can do them for free. On my website, www.bloomassetmanagement.com, we have a variety of free documents that you can use.
If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.