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Money Matters
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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.
Niki

Dear Niki,
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.

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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

More Money Matters columns
See Also
Cut your college loan costs
The cost of applying to college
Financial advice glossary
More Money Matters stories

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