Mortgage interest rates have declined in recent years, prompting many homeowners to consider whether they should refinance as a way to swap their higher rates for current, historically low ones.
For homeowners with children near college age, extra cash freed up by refinancing — whether through lower monthly payments or through a lump sum taken out as part of a “cash-out” refinancing — can be a potential source of funding for college.
NerdWallet asked two financial advisors from its Ask an Advisor network — Brian McCann from San Jose, California, and Stephen Hart from Plano, Texas — about key factors homeowners should keep in mind if they’re considering these strategies.
Is refinancing a viable alternative to popular 529 plans?
Brian McCann: No. A 529 plan is a savings plan. It is designed to allow tax benefits for saving for college over time. Your home equity is a store of wealth. Tapping it for your child’s education is kind of the opposite of saving over time. Plus, if you end up with new, higher payments and run into financial difficulties, you can lose your home.
Stephen Hart: Too often we see individuals that want to try something like refinancing to fund 529 plans, or similar schemes, all the while maintaining thousands of dollars in credit card debt that costs them 20% a year. My recommendation is to always consider your entire financial picture, assets and liabilities, goals and objectives.
Is refinancing better than withdrawing from retirement accounts to pay for college?
BM: If your interest rate is lower than the long-term expected return of your retirement account, this would be the better option. However, neither are very good options.
What else should consumers know before they decide?
BM: Your child may be able to get loans and financial assistance for college. No one will loan you money for your retirement. Since many families’ only real store of wealth is in their home, I would be very reluctant to touch it for anything but the most severe financial hardship.
SH: I see decisions like these made in a vacuum. Clients see the benefit of lowering their monthly rate and the increased cash flow, and that’s as far as their analysis goes. For many, refinancing does make sense, but it should be made in light of closing costs and how it affects other goals. Each decision should be made with the understanding that your financial future is your own, and while you may see a small benefit today, it can affect you long-term both positively and negatively.
The answer, of course, is to have a financial plan in place that guides your decisions, and a full understanding of which assets are working for you the best and which liabilities are dragging you down the most.