Restructuring debt before graduate school


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Dear Dr. Don,
I just gained admission to a top 10 business school. That’s the good news. The not-so-good news is that I’ll be looking at paying full tuition of about $85,000 a year. I have $20,000 in credit card debt without much in savings.

I have $50,000 in a 401(k) plan and $100,000 of equity in my home. The home is worth about $225,000 with $125,000 in loans against the house.

I do not want to leave the property. The rent I receive covers all costs and some extra income. I’d like to eliminate credit card debt. Would you recommend a home equity loan, a private loan or borrowing from the 401(k) to pay off the debt?

Thank you,
— Ross Restructure

Dear Ross,
Congratulations on your admission to a top business school. If you’re quitting work to go to school, you won’t be able to take out a 401(k) plan loan to pay off your credit cards. The plan loan would become due as soon as you quit the job. Let’s look at other options.

If paying off credit cards, you’d essentially be restructuring finances by replacing unsecured credit card debt with some other form of debt. Be careful not to allow credit card balances to creep back up over time while in school or afterward.

If choosing between a home equity loan and a private loan, I’d lean in favor of the home equity loan. It should carry a lower interest rate than a private loan. Interest expense should be tax deductible.

A key question is how much equity you’ll be able to tap since the home is a rental property, not your personal residence.

You shouldn’t have a problem getting sufficient funds to pay off the credit cards. But getting enough money for tuition payments could be a tougher question.

As I write this, the Bankrate national average for a home equity line of credit, or HELOC, is 4.85 percent, while a home equity loan is at 6.12 percent. The HELOC is an adjustable-rate loan, so you would face risk of rising rates. It is interest-only in the early years of the loan.

Good luck with school!

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