Paying off a son's student loans
Dear Money Matters,
I would like to pay off my son's school loans -- about $9,000. I'm
retired and have $90,000 in a rollover at Morgan Stanley that is
doing nothing. Or, I could use a zero-percent credit card and get
the money. Then he could pay me.
We should all have a parent as generous as you. My first advice
would be to avoid the zero-percent credit card. The zero percent
is just a "teaser" rate that will inevitably go up after
a few months.
If you're lucky, the rate will go up only to the low
teens, and your son will quickly pay off your largesse. If you're
unlucky, you'll be saddled with a high-interest credit card and
a sizable balance.
On top of that, if you use your own available cash
to pay off the credit card debt before it jumps past zero percent
interest, you're effectively doing the same thing as simply giving
him the money to pay off the loan. The only difference is that the
card will likely give you a few months' grace period before you
have to tap into your cash reserves.
The most simple and certainly the most cost-effective
means of paying off your son's student loans is to access the money
you say you have at Morgan Stanley. I have to do some interpreting
here, but my guess is that your money is in a cash management account
drawing a modest amount of interest rather than in something with
a bigger payback, such as a stock or mutual fund (at least that
would be my view of money that was "doing nothing.") If
that's the case, you should feel free to do so -- your money is
likely earning less in interest than that levied by your son's student
loans, so paying off a higher interest rate with funds that are
earning less in interest is sensible.
If you'd rather not earmark that amount at once, another
option is tapping into your home equity with either a loan or a
line of credit. Like a student loan, these are relatively inexpensive
-- the going rate for a loan is 8.25 percent, while the line of
credit is even lower at 5.29. Other pluses include tax deductibility
and modest monthly payments, since the $9,000 you'd plan to borrow
is relatively small. To illustrate this, I ran some numbers on a
home equity loan lasting 15 years (a common lifespan). Your monthly
minimum calculates out to a puny $87 a month.
The downside, however, is that you are accumulating
interest costs for as long as you have the loan. For instance, should
you dutifully pay the $87 a month for the full 15 years, you spend
more than $6,000 in interest charges. Granted, you could always
pay off the loan faster than the prescribed schedule or opt for
a line of credit instead. This functions more like a credit card,
as the interest rate changes and what you owe from one month to
the next depends on the outstanding balance of the loan. In either
case, you're still taking on interest charges -- something you skirt
completely by just giving your son the money.
You might also look into how your son's loans are
structured. He may be able to consolidate
the loans at extremely favorable rates -- better than what you
can get in a home equity loan or line.
Should you decide to tap into your available cash,
the last issue you need to tackle is, in many ways, no less important
than the means you choose to get the money. The question is how
you want to give your son the money -- will it be an outright gift
or would you rather structure it as a loan with a schedule of payments
and possibly an interest rate? Money
and family can often be a dicey proposition, so give this thought.
Some people might prefer the parameters of a formal loan. Unfortunately,
that can often backfire, since the obligation to meet monthly payments
simply isn't as strong as it would be for a bank or other lending
institution. And that can lead to family squabbles.
My advice -- give your son the money as a gift
with the proviso that, should he be able to sometime in the future,
he should feel free to repay your generosity. This strategy makes
the gift less of an outright handout without running the risks of
straining family relationships that a formal loan can carry.
-- Posted: July 10, 2002