Ask the Piggy Bank: Reader Debt Question — College, Home Equity, or Car Loan?
November 6, 2008 by Miranda Marquit
Filed under Finance
I got this email from a reader not too long ago. And I think it deserves some attention. And your help as well:
We make $ 95,000.00 per year before taxes. Husband and wife both work. Have excellent credit.
We have a $102, 000 remaining on 20 years left on mortgage.
We have a $ 7,600 Home equity loan.
We have a $ 13, 500 Car loan.
We have $8,000 in our savings/emergency fund.
We or our Daughter will need to borrow $17,000 for College next year for fall of 2009 College.Should we:
Pay off the Home equity.
Pay a chunk of Car loan.
Don’t pay either, because we won’t get a 17K loan next year, so we’ll need the 8K for college.
This is an interesting question. First, I’ll let you know what I think. And I hope that Yielding Wealth’s readers will add their two cents.
First of all, it’s great that you appear to be in such good financial shape. I assume that you don’t have credit card debt, since you did not mention it. I also assume you are able to make all your payments, since you seem to be in a good place.
My main question is where this 8K is coming from. Are you planning on raiding your emergency fund in order to pay something off? In these economic times, I actually think you should build your emergency fund further, since you never know what could be happening. My first suggestion would be to not use the the money in your emergency fund to do any of what you are considering.
Kids and college
Personally, I believe that kids should cover their own tuition expenses. I don’t know whether the $17,000 is tuition + other expenses. In any case, kids can cover their own tuition through scholarships, part-time jobs or even loans. But I’m biased, because that’s what I did. My parents paid my rent and my car insurance (I bought the car), and I took care of the rest. I recommend that you let your daughter take care of tuition. Even if she has to do loans, she will have much longer to pay them back, and you don’t want to put your retirement at stake.
Paying down your consumer debt
Next, if you have leftover money (again, I do not think it is a good idea to raid your emergency fund) after making sure you are funding your retirement account and emergency fund and helping in a small way with your daughter’s college costs, I suggest that you start paying down your other debt. Start with the highest interest debt. In your cases (assuming you don’t owe on credit cards), it appears that your car loan probably has the highest interest rate.
Take care of the home equity loan next, since I really lump that in with consumer debt. Besides, you are probably getting a tax advantage from the home equity loan interest (as well as the mortgage interest), so paying off the car loan first makes sense. Then, when the home equity loan and the car loan are both paid off, you can make extra mortgage payments.
It’s great that you are working toward financial freedom. Indeed, it appears that you are already more than halfway there. The choices you make now will affect whether you get there sooner — or later.
Readers: What do you think this reader should do?
What are you going to pay the extra with? If it’s with the savings than I say don’t. If you use that then you don’t have emergency savings anymore. I agree that college is about last. Your child can take care of that herself if needed. You can’t expect her to pay off your expenses or retirement so those things need to be taken care of first. I’d like to know what the interest percentages on the debts are and what kind of loans they are. Is the home equity loan a variable interest rate? How about the home loan? Rather than pay them off you may want to lock in a low rate then pay them off. If the car loan has low interest it may not be worth it to pay it off. I think we need a better picture of the finances before advice is given.
Good points, FFB! We do need a few more details to give better advice. But I think we’re off to a good start. I especially like that you point out that daughter’s college should be the last priority. It’s a nice thought, but you don’t want to sacrifice your own financial well-being for someone who should be learning to take care of herself. That ultimately doesn’t help anyone.
Great question….great idea for posting it!
Compared to majority of Americans you look like you are in great financial health (judging from what i see above)…so great job!
Here are my thoughts:
Primarily I am of a no debt philosopy, because I believe “a burrower is servant to a lender” and debt is the inherent root of the current US crisis (i’m not going into good and bad debt here)
I agree with Miranda’s response….but I disagree on the kids having to pay for their school.
Firstly you don’t want to introduce your daughter to the concept of debt, so you don’t want her starting her journey through life burrowing for college (which is a heavy burden once college is done), although you may have limited control on whether she takes on debt further down in life, but you want to leave her a legacy of “I don’t support debt”….so the question is how do we pay for the college?
- Consider her going to a 2 yr community college to save money in the first two years, and later complete college wherever she wants
- pay as much of her tuition as you can pay (inherently you’re passing a message of “do this for your own kids so they can be a richer generation”
- Have her work so she can pay some of her tuition, and teach her the no debt philosophy also (introduce her to the concept of frugality and responsibility)
You want to teach her to be responsible, and live debt free, but you don’t want to be one of the people that say “I took care of you up to college, now you’re on your own”, the rich don’t do that, and you are rich!
Sorry for digressing…so attack aggressively your car loan, I think $8k in emergency funds is way too high, are you anticipating some major pocket shattering disaster? else take some of the $8k and make extra payments on your car loan and leave some to assist your daughter in college.
phew…i had much more to say but, i’ll stop here
Interesting thoughts, even though I disagree with the college matter. At some point, the daughter will have to buy a home or a car — things that generally require debt. Learning to borrow a very small amount, and to be responsible about debt, is part of a well-rounded financial education. And, while I think that it is important that parents help their children, I don’t think that completely taking care of them is the answer, either. At some point daughter will have to be responsible to make her own financial way, and college — with some parental support — is a good place to start learning these skills.
As for the emergency fund, in this climate where unemployment is rising (my uncle just got laid off, and my dad is worried), a pocket shattering event is very likely. It is a good idea to have a couple months worth of expenses saved up.
Slightly different perspective here as I’m from the UK. This means taking out loans for university isn’t as common as in the US because alot of students get state funding, esp. for tuition. Everyone else is expected to go get a part time job … this is education for adults, right?!
Like most others here I’m a great believer in reducing debt asap. However no-one’s mentioned investment. $8K is a very nice savings pot and I’d be tempted to skim something off and put it in something long term. Tracker or something like — I said long term ;)
Also, again because of the UK perspective, the interest rates for the loans/mortages matter to me. These can vary by up to 5 percent in the UK, depending upon provider etc. So which ever’s the highest/longest is the one to pull down.
However, I’d also keep between $4-6K in that reserve .. find a nice bond to tie it up in for a year or so. So if you do decide to invest in a tracker, that’s probably it.
I definitely agree with your thoughts on kids and college. (I remember Suze Orman giving the same advice on Oprah once, and I thought, “You know what? YES.”) After the first year (which was also helped along with scholarships and grants), both my sister and I paid our own ways (with same scholarships and grants, as well as loans and jobs).
Chris: Thanks for your insight. I agree that investing it is probably a good idea — something cash, perhaps, for the short term.
Alicia: Thanks for your thoughts. I had a scholarship (part-tuition) and a part-time job, as well as small student loans to help me with my tuition through grad school. I think it’s taught me a lot.
True she would have to take a financial decision on her own, but my idea is learning to take such decisions without debt. So even if she has to take something on using debt in the future, she will carefully consider it.
Majority of people say having a college kid pay for their own tuition is “good financial education”, which is true, and some would argue also that having a kid pay for high school is good education also. I don’t think both are good.
definitely it is a pervasive phenomenon in the US for kids to pay their way through college, especially with school loans…..but I don’t really see the financial education in piling a load of debt at 8% to be paid of in 10 years, on a cash basis, it is good!
I guess the big question is this: whatever lesson an individual picks up from paying through school with a school loan, assume the lesson was learnt beforehand and he/she graduated without any school loan, would life be much better in the future?
So my point is this, if we want to give our kids good financial education, let’s teach them the following:
- stay away from debt as much as possible
- be frugal
- start a business and become an employer
- lead a charitable life
I do agree that it is important to go with the items on your list, Moyo. I would emphasize, the AS MUCH AS POSSIBLE with the debt. Yes, you should keep debt to a minimum. But in some cases, it is necessary. My student loans, happily, are at 1.5%, and they will be paid off in much less than 10 years. I think the important thing is to make a plan for it, and be prepared.
I especially like your point about leading a charitable life. Definitely very important to well-rounded finances.
Though the parent’s income is good, their savings and debt don’t seem to be in a position where they should be taking on more debt for their daughter’s sake.
My parents helped me through school, though they couldn’t really afford to. Now, they have hardly anything in savings and plenty of debt. I feel terrible and so guilty.
They can’t take a loan out for retirement. I could have borrowed money for school.
Thank you for sharing your thoughts, Kacie. You make an excellent point: It is easier for young people to borrow for school than it is for older people to get what they need close to retirement.
I’d focus on maximizing the monthly cash flow. Starting with minimizing expenses. The situation will be different in 12 months depending on if you clear $500, $1000 or $2000+ per month. That also helps to increase the power of your emergency fund. An $8,000 e-fund with $4000 expenses = 2 months, but with $2000 expenses = 4 months. Hope that helps. Best of luck!
Thanks for your thoughts, Sean. I think that it is a good idea to look at cash flow, and include that into the equation.
First and Foremost great job at managing your debt load. The home equity loan you are carrying is one of the last things I’d paydown, unless of course you are paying an outrageous interest rate. My guess is that you are tied to prime or libor and have a relatively low rate; furthermore the interest is more then likely tax deductible for you.
While 8k is a nice start to a nest egg, I would suggest continuing to build this up. Perhaps put the 8k in a high yielding money market savings account. I’m not sure what sector of the economy you work in; hopefully you are relatively sheltered from a potential layoff, but having a little larger cash savings account can really come in handy for a rainy day!
Thank for your thoughts, FixThePig! You make a good point that 8K is a good start, but that it doesn’t hurt to be prepared with more.
Your advice on having the daughter take care of her college expenses was great. Maybe this will motivate her to continue looking for scholarships or consider a lower cost option, at least for the first two years. Student loans are not a default option.
The parents can support her without paying for college.
Thank you for sharing, Laura! I agree that there are other ways to be supportive without paying for college — or all of it at any rate. And I do like the idea some have floated about a 2 year school. My husband started out at a community college to save money, and he’s been just fine.