HELOC vs. Parental Student Loans vs. Second Mortgage?

Question

First to set the stage.

• We have two kids one starting school this fall and another following in two years.
• As a family our income is high enough that we do not qualify for any aid.
• We also make too much to claim any education related deductions.
• We are very asset poor, little savings, I'll explain below.
• We have about $30k in usable equity in the house.
• We are looking at $20k of education expenses per kid per year.
• We are planning on contributing $12k per year and then have our kid cover the rest in loans.
• We are basically taking $1k out of the family budget and sending it to the university.

The options I see:

At this point we do not have the cash on hand to cover the costs of Progeny #1, but we have been offered a Parental Student Loan to cover all of her costs. But I wonder if using the house might be a better idea, here is what I see as options:

1. Take the parental student loan

   • I don't like that this debt
   • Student loans cannot be discharged (god forbid something happens)

2. Get a HELOC

   • Five year term for borrowing
   • Pay tuition then pay down every month (works with the budget)
   • Interest might be deductible
   • Feels like less debt

3. Take out a 2nd Mortgage

   • Cheaper interest rate
   • Need to take all at once

At graduation I would like to think that we had payed off all of the debt associated with their schooling (on our part). But, I am also a realist and know with all the best intentions how easy it is for us to screw things up.

Back Story

We are in kind of a uncommon situation, now both my wife and I are making good salaries and are now climbing up to a point of zero net worth. We should be further ahead at this point looking at what we make, but the great recession hit us hard and then one of our kids got very ill. Not all the treatments suggested by the doctors were covered by insurance, so we paid for them out of pocket.

The good news is that one of those treatments finally worked and we have our kid back! It only took everything we owned, and I would do it again tomorrow in a heartbeat. That is also how I know we can cover the $1k a month for college, that is money we are paying on medical debt that will be payed off and we can then redirect to other things.

Edit #1

I appreciate the suggestions about community college and other ways to save money. But, I would really like to limit the suggestions to the question on hand. Both my wife and I are in "high skill" educated jobs and I see how the school pedigree sets a person's life long trajectory. In my mind the local state university is pretty close to the knee on the cost/value curve and we are willing to sacrifice to support that choice.

Answer 1

Thank God you have your child back, it is so awesome that you finally found a medical treatment that worked. It must have been a truly trying time in your lives.

That situation is an important template in personal finance. Through no fault of your own, a series of events occurred that caused you to spend far more money then you anticipated. Per your post this was complicated by lost income due to economic situations.

What is to say that this does not happen again in the future? While we can all hope that our child does not get sick, there are other events that could also fit into this template.

Because of this I hate all options you present. Per your post, you are pretty thin with free cash flow and have high income, and yet you are looking to borrow more. That is a recipe for disaster with it being made worse as you are considering putting your home at risk.

The 20K per year per kid sounds like a live at the university state school; or, a close by private school. Your finances do not support either option. There are times when the word "No" is in order when answering questions.

Doing a live at home community college to university will cost you a total of about 30K per kid rather than the 80K you are proposing. Doing this alone will greatly reduce the risk you are attempting to assume. Doing that and having your child work some, you could cash flow college. That is what I would recommend.

Given that you are so thin, you will also have to put constraints on college attendance. No changing major three times, only majors with an employable skills, and studying before partying. It may be worth it to wait a year of two before attending if a decision cannot be made.

I was in a similar situation when my son started college. High income, but broke. He worked and went to a community college and was able to pay for the bulk of it himself. From there he obtained a job with a healthy salary and completed his degree at the University. It took him a little longer, but he is debt free and has a fantastic work ethic.

Answer 2

I'd like to propose a 4th option:

Let your kid(s) take out their own student loans, and then you can make payments directly to help them pay them down.

Some advantages to this method:

1. Similar to the HELOC and Parental student loans, the debt doesn't occur until the tuition is actually paid, so your overall interest is lower (compared to the second mortgage on your house).
2. It sounds like you may not be able to deduct interest on a parental student loan, but your kids probably will be able to deduct their student loan interest when they start working. (Though you should be able to still deduct the HELOC too.)
3. You have better control over how much you pay towards your kid(s) loans, and when. Perhaps in the future your income situation will change and you won't be able to make as big of a contribution as you'd like, or perhaps you'll have much more income and can make significantly larger payments. As long as your kid(s) choose a profession and obtain a job in which they will be able to afford to make the minimum payments on their loans every month, you can pay down as much principle beyond that each month, and you can adjust that amount every month based on how much extra you have. (Note this is similar to the HELOC too.)
4. There could be a psychological benefit. If every payment you make to your kid's loans in the future is thought of as a "gift", then they may be less likely to stop calling, or visiting, or helping you when you need it, etc. Simply because if they do, it would be reasonable for them to expect the gifts may stop too, or decrease in size.
5. If one of your kids starts making a very good income, it wouldn't be out of line for them to tell you to stop making payments on their loan and just double up on their sibling's loan.

Note the many similarities to the HELOC, which would probably be my second choice.

Answer 3

Debt is no fun. Getting out of debt to replace it with more debt is no fun. In both cases, you are making an investment in your child's future. That's laudable, but there might be other ways to economize on the education costs.

I prefer HELOC debt because I can deduct the interest (as you pointed out) and it usually allows re-borrowing if other cash-flow problems crop up. The downside of borrowing against your house is that your house could be foreclosed if you become insolvent, and you will lose your buffer if you max out the equity now. The same problem exists with a 2nd mortgage. The fact that you would still have a mortgage either way does make the option more attractive though (or less unattractive anyway).

Answer 4

First of all, I'm happy that the medical treatments were successful. I can't even imagine what you were going through. However, you are now faced with a not-so-uncommon reality that many households face.

Here's some other options you might not have thought of:

1. Cheaper school for two years
2. Kids live at home instead of on-campus
3. Sell some things to raise money
4. The kids gets jobs while they're in school
5. Apply for every scholarship you can find.

I would avoid adding more debt if at all possible. I would first focus on the the cost side. With a good income you can also squeeze every last dollar out of your budget to send them to school.

I agree with your dislike of parent loans for the same reasons, plus they don't encourage cost savings and there's no asset to "give back" if school doesn't work out (roughly half of all students that start college don't graduate)

I would also avoid borrowing more than 80% of your home's value to avoid PMI or higher loan rates. You also say that you can pay off the HELOC in 5 years - why can you do that but not cash flow the college?

Also note that a second mortgage may be worse that a HELOC - the fees will be higher, and you still won't be able to borrow more that what the house is worth.