Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Refinancing for debt consolidation

Dear Dr. Don,
We have a $57,000 mortgage on a three-year ARM that we need to refinance one way or another. This will not be our final home.

We are in our late 40s with an upcoming college student in five years and retirement looming on the horizon. We have $28,000 in truck and boat loans, which are not tax-deductible.

We plan to stay in our home for five years. Our home is valued at $125,000. We are becoming concerned about taxes hitting us more and more. What is the best plan of action for us? Thanks for your help. I enjoy your columns.
Heather Homeloan

Dear Heather,
Using a cash-out refinancing to pay off the truck and boat loans along with refinancing the adjustable-rate mortgage should be a slam-dunk. As long as you can use the mortgage interest deduction on your taxes, you'll gain the interest deduction from that part of the mortgage loan that you took out to pay off the car and the boat loans.

The stickier issue is whether it makes sense for you to borrow money now to invest for your child's education. The simple answer is no, don't do it. Even though borrowing against your house is likely to be your least-expensive source of borrowed funds, you're still only making the difference between the after-tax return on your investments vs. the after-tax cost of debt.

Even if you deposit money from the loan in a Section 529 College Savings Plan, making the investment returns tax-free when used to pay for qualified college expenses, you're still counting on the spread between the investment returns and the after-tax cost of debt being positive. While that's likely, I don't think that's your best approach to financing college this close to your child's planned enrollment.

You expect to sell your home around the same time that your child starts college. The capital gains provisions on home sales are much more liberal than they used to be. Under current tax law, it's unlikely that you would owe capital gains taxes on the sale of this home. See IRS Publication 523, Selling Your Home for tax implications.

You could count on using part of the profits from the home sale to help finance your child's education. If you don't sell the house, the equity will still be there to tap, and you've avoided paying interest on that amount over the five-year period.

-- Posted: Dec. 31, 2001