Is this correct? Financial aid questions.

goaliedad
Fri, 25 Apr 2008 12:43:49 +0000

As I see it here, the OP is trying to manage a couple of things.

First, the management of assets vs. certain categories of debts. On this count, as other posters have mentioned, consumer debt hurts you in FA analysis as it is not included in net asset calculation, whereas mortgage debt helps in most Profile situations, as it does decreases your net assets (for schools who include home equity).

The second thing which I see needing to be discussed is cash flow. Right now has a mixture of consumer debt that has varying payback schedules over the next 3-? years. OP is considering whether to use home equity debt to not only affect the FA estimate, but I would also assume to lower payments freeing up more current cash flow for college EFC.

I see 3 ways of using home equity to address this consumer debt which can be used singly or in combination. I’ll list each with pros/cons.

1) 2nd mortgage - that is fixed amount at a fixed rate for a fixed duration. Pros - You know exactly how much you will be paying and for how long. Doesn not extend the life or terms of your current mortgage. Cons - It is a one time shot that usually has fixed fees associated with processing. If a “3rd” mortgage is needed later, it just adds to the cost. Probably a higher initial interest rate than other loan products.

2) Home Equity Line of Credit (HELOC) - Pros - Usually has a lower initial rate. Usually have minimal (or sometimes no) fixed upfront costs. Allows borrower to take out additional debt in only the amount needed (for up to 5 years usually) with minimal (if any) transaction cost as it is needed which can be very useful for paying debt that accumulates over time (like college tuition!). Most allow interest only payments during the debt accumulation period, minimizing borrower cash outlay. Usually converts to a fixed rate (based upon an index) once the debt accumulation period ends. Cons - Variable rates during debt accumulation leave uncertainty of monthly payment. Final rate set in future (at end of debt accumulation period based upon an index) highly likely be higher than a fixed rate today. Maximum payoff term may be shorter than 2nd mortgage (check with lenders for specific programs).

3) Refi current 1st mortgage (fixed rate) - Pros - If you are significantly into your current 30 yr mortgage (10 years or more), you will lower your monthly payment on ALL of your debt, not just the consumer debt. Overall interest rate on total debt will probably be lower than any other method. Overall monthly payment will be lower than all other methods during the college period. Cons - you will be paying for your home mortgage a lot longer. May require more paperwork up front or more fees. If your original mortgate was taken out at the lowest rates in the last 10 years, you may actually not save money, but you need to do the math to figure this out.

Personally, if you are committed to using your resources (income and home equity) to finance your share of the EFC (hopefully you’ve followed other advice on CC and gone through the EFC Calculators and added a bit for “gapping” or required loans in FA packages), I would probably do a refi now (if the math works correctly - rates today compare favorably or equally with your current rate) and when you come to the point in college where you cannot fund your child’s tuition bills out of cash flow or subsidized loans, go with an HELOC (given the rates compare favorably with unsubsidized educational loans). If in the time before college starts, your payments have dropped to the point where you have excess cash flow, you can either make additional principal payments (shortening the refi’d mortgage - it doesn’t take much to chop off a couple of years) or just accumulate the cash in liquid form anticipating the payments of the first year tuition and delay the time you need a HELOC.

More importantly, you need to change your spending behavior to not require consumer debt going forward, as it indicates that you are spending more money than you are taking in - a bad sign for the future.

Hope this helps.