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I fear I did something stupid.

I graduated in 2017 with a bunch of student debt that my parents held on my behalf (~$130k). One misunderstanding led to another and somehow we ended up refinancing the student loan with a mortgage on my parent’s house. I was under the impression that this was going to be a lower interest rate than another refinancing option, but it doesn’t seem like it (6.5% interest rate).

The arrangement we currently have is that I pay the loan bill monthly (have been paying 2.5x minimum for almost 2 years).

Obviously, this rate is very undesirable and I should’ve done more research. Is there anything I can do to leverage that this was a past student loan?

If not, can I refinance this under my name for a lower rate? I suspect it’s a high rate because it is a second mortgage. I have a high credit score (~790), make about $130k/yr, am 24, and have assets (incl. retirement) of about $90k. I live in the US.

The current loan has a $110k principal remaining with a 10 year draw period and a 20 year repayment period.

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    Is it still considered a student loan? That is to say, is the bank aware that it is a student loan, and thus not dischargeable in bankruptcy? Are you a registered owner of the house? – Harper Jun 26 at 11:41
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    Is there a reason you want to hold 90k in assets with 110k in debt with a higher-than-desirable interest rate? – Chris Jun 26 at 19:42
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    Keep in mind (for the future) that refinancing almost always means "take a new loan to pay off an old loan", not "modify the terms of an existing loan". – chepner Jun 27 at 14:39
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    You have a $130k debt, make $130k per year, and have parents who are willing to help you out with stuff. I would live at home for a year and a half and spend $0 on anything; just pay the whole loan off in that time. – GendoIkari Jun 27 at 15:31
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    @Gendolkari - fair if I lived near my parents. I think that comment fails to consider the constraints one has on a job that makes $130K a year (ie working remote or changing jobs) – smartButNotSavvy Jun 28 at 9:49
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The student loans are gone, all lenders see is a 2nd mortgage. Since the mortgage is secured by the home you'd likely have a hard time getting a better rate on an unsecured loan, but it doesn't hurt to go chat with some lenders and see what options exist.

I imagine the best chance for a lower rate would be a re-finance on the first mortgage (assuming there's enough equity after both mortgages are factored in). Downsides on that would be muddling of the two mortgages, whereas now even though it's in their name you are paying a separate loan.

One potential consequence here is that you may have lost the ability to deduct the student loan interest paid, but unless you're married your income would have precluded the deduction anyway.

It's certainly worth seeing if you can get a lower rate loan, but it's very possible that the fees/rates won't be compelling enough to go through the hassle. With your income level, the best option is probably to do everything you can to pay down that debt in the next couple years. At 6.5% I would forego all retirement investing other than 401k up to company match and pay down this debt in a hurry.

The good news is that you have healthy income and are young enough to quickly recover from an unfortunate interest rate.

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    Thank you; this is exactly the advice I’m looking for. When you say “forego retirement investing”, does that mean on a go-forward basis or would you recommend liquidating all other liquid investments? For context, about half of that $90k is in my 401K/Roth IRA with the other half in a regular investment account – smartButNotSavvy Jun 25 at 17:53
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    @smartButNotSavvy don't liquidate the retirement assets, but you may want to seriously consider using the non-retirement investment money to pay down the debt. It's hard to beat a 6.5% guaranteed return. – Kevin Jun 25 at 18:00
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    Even refinancing just the second mortgage right now may get a better rate without rolling it up with their first position mortgage. Rates are historically low right now. It doesn't hurt to talk to a bank or credit union and ask for options. – dwizum Jun 25 at 19:50
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    @smartButNotSavvy in fact, delete the idea from your brain of ever liquidating retirement income before retirement. (Or borrowing from it). The tax penalties for doing so are murderous, the money can't ever be replaced so the power of compounding is lost, and you waste the inherent asset protection built into 401K's. Your 401K is immune to lawsuit and bankruptcy, it has one purpose, solvency in your retirement, and can't be used for anything else unless you are stupid. Your life will have 100 emergencies. don't blow the 401K on one. – Harper Jun 26 at 11:47
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    "The most unfortunate consequences here is that you/they lost the ability to deduct the student loan interest paid." OP mentioned a yearly income of ~$130k. Wouldn't they not qualify to deduct student loan interest (since it's greater than 80k (2018) and 85k (2019))? – Joshua Taylor Jun 26 at 13:21
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Recourse

A "recourse" loan is one in which the creditor can go after you personally for the balance. For instance first mortages are generally non-recourse loans, after the lender takes the house, they cannot pursue the borrower for the rest of the money.

Student loans are the ultimate recourse loan not written by actual mafia, because student loans ignore bankruptcy and statutes of limitations, and can chase you for the rest of your life.

If the second mortgage is a recourse loan, your parents can escape it by filing bankruptcy, or functional equivalents. If it's non-recourse, it's even easier - just walk away from the house and your student loans are gone (in exchange for some marks on their credit report).

Either way, this is a big upgrade from that nasty student loan, if we consider your family as a single unit. If we do not, then it's an even bigger upgrade, because problems in this loan won't even show up on your credit report, to be dreadfully mercenary about it.

Realistically, this is the weak spot here. Effectively you have borrowed money from your parents and put them in a heck of a spot. You need to cover that 2nd mortgage, or they take the credit hit and they lose their house.

On the other hand, they may be able to tax-deduct their 2nd mortgage interest, and so you may want to arrange something to have this passed back to you. This makes the interest rate more favorable.

The danger

The #1 thing that goes wrong in this scenario is you stop paying and they don't know you stopped paying. Typically (like cosigner situations) the first they hear of it is a bad mark on their credit report -- because unbeknownst to them, the situation went 30, 60 days past due. If only the other person had known, they could have easily made the payment as they did promise to do, and avoided the needless consequences.

So I would change the "pipelining" of how these payments are paid. I would have you pay your parents, and have the parents pay the mortgage. That way they are intimately aware that the payment is being made, since they are making it.

If you make this routine and normal now, that will completely avoid the awkwardness and humiliation later to man up to tell them timely that you will be unable to make the next payment, or the relationship-breaking cowardice of failing to do so. Further, if you do their part and they fail; the consequences fall on them where it belongs.

401Ks, IRAs and the like

None of this is any reason not to max out your 401K and do a non-deductible IRA to boot.

I don't mean "to the employer match"; that's waving a banana in front of a monkey. It's a sad state of affairs that we must resort so such cheap chicanery to get people to do the smart thing that would be obvious if they had any financial education at all. The whole point of the match is to get people to start thinking about what retirement saving actually is, on the hopes that they start to grok "Wow, this is the best deal in the history of money, and will make a huge difference in my elder life!"

I found myself on a Board managing an endowment: a "forever" chunk of capital where the university's program is funded by the appreciation. These are tightly regulated, and there's a "gold standard" for how they MUST be invested - heavily in equities where the growth is (and the volatility, but you don't care about that on a long term investment). Correctly done, you double your capital every 7 years on average, over the long term. You're making 10, 11% effective interest.

At 24yo, your 401K/IRA gets invested likewise. The needed funds are available in your 401K.

Everybody has something better to do with the money today. But if you wait til age 31 you'll only have half the money for retirement. If you wait til age 38, 1/4 the money. This multiplying power (of compounding) makes it very urgent you max out the 401Ks today, and then, also max out a non-deductible IRA (and immediately convert to Roth, since this is free to do). If you contributed the max from age 24-33, then stopped, you'd be better off than if you started contributing the max at age 34 and continued until retirement. And I'm sure $20k/year extra in mid-career would be helpful, sure beats playing "catch-up" on retirement because you started too late. Struggle a little now, take big payoffs later.

Relating to student loans, I recommend maxing retirement first, because it grows faster than the student loan interest costs. But still at your salary you should be able to knock both out.

I'm sorry to beat the drum so hard, but investing for retirement early is so ridiculously overpowered when you are young. Take full advantage of it!

And never, never, never cash out a 401K early. They are fully protected from lawsuit and bankruptcy. In some states, IRAs enjoy the same protection. Life will be full of emergencies that seem fixable with a big shot of cash. It always seems that way and is rarely true. The power to resist throwing money at every problem is an important wealth skill.

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    tl;dr. Can you summarize this, or remove what's not essential? – RonJohn Jun 27 at 0:54
  • @RonJohn - I concur. I usually don’t comment on this, but I’ll admit, when answer run over one page (it’s the end of 2nd para of 401k heading) I think this myself. I’m guilty of it sometimes as well. – JoeTaxpayer Jun 27 at 1:23
  • @RonJohn I can reduce it to two words: compounding works. However, my goal here is to persuade. You don't need persuading, so I'm sure it's deadly dull for you. – Harper Jun 27 at 15:10
  • @JoeTaxpayer Mark Twain is attritubuted with "I didn't have time to write a short letter, so I wrote a long one instead". I can be guilty of that too, but this isn't that. Having tried, I don't see a simpler way to persuade of the urgency due to value of compounding (and further, the power of compounding due to long-horizon investment gains rates). I could armwave any of several things, but that damages credibility or raises inveitable questions. – Harper Jun 27 at 15:22
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    "they may be able to tax-deduct their 2nd mortgage interest" Not a parent, but I'd say OP's parents have earned the tax break, considering the risk they've taken on. – jpaugh Jun 27 at 17:53
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You say you have 90k in assets. I would tap most of these to pay down the loan, saving 3 months for living expenses.

Some ideas:

  • A 401k loan (up to 50% of the value of the plan) would save you 6.5% on the amount, which is a risk-free tax-free return that you probably won't get in the market. Caveat to this: if you lose your job you will need to pay this back immediately. Given your high income the risk window should be short while you pay this off (< 2 years)
  • If you have positive equity in your primary residence you can refinance some of that equity out at a lower interest rate than 6.5%
  • Cash out stocks/ETFs/mutual funds (avoiding short-term capital gains). Even though you'll pay tax on the gains, the cost is very much lower than 6.5%.

In my opinion cashing out some of the 401k is not a good option here - partly because of the 10% penalty (though 1.5 years of carrying this debt negates that cost) but because you can't deposit that money back once it's out and the 401k cap from previous years is lost.

After this, you have 30-70k left to pay off (assuming 10k emergency fund) at a lower interest rate and have simplified the loan by removing your parents from the equation entirely.

  • 401K loans are the opposite of risk-free. If anything happens that causes you to leave your job, BOOM, the entire note is due and payable in full. Unless you can readily get another loan (e.g. recession job loss), this will force liquidation of part of the 401K, adding paper income at your top tax bracket, plus 10% tax penalty. This late in a long bull market, "won't be a recession" is a bad bet. Also you may want to clarify "hold the stocks/ETF/mutual funds to the 1 year point to avoid short term capital gains", then cash them. – Harper Jun 27 at 18:05
  • Risk free as in, not subject to fluctuations in market values. I agree that there is a personal risk to taking out the loan. At high levels of income (130k) the window of that risk exposure is limited and so IMO it's an acceptable risk to take. Worst case scenario you need a new loan if you leave your job, which is what the OP has now. Worst-worst case it's not possible to get a new loan, you're out of work and you need to take the money as a distribution. – Chris Jun 27 at 20:01

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