Dear Dr. Don,
I recently refinanced my mortgage, taking some extra cash for a family emergency. The short-term cash crunch was resolved and my finances are back to normal. I am wondering whether I should use the cash to pay down my home mortgage or simply put it in my son's 529 college savings plan. My son will be going to college in three years. But, I'm concerned that if I put too much money in the 529 plan, it could negatively affect his chances of getting financial aid. On the other hand, I wonder if I put the money toward my house, there will be less in my bank account and the 529 plan. Would that help my son get more financial aid? I could take another cash-out refinancing if there's not enough financial aid to support his tuition. Which strategy is better?
There are many variables here, so giving you a definitive answer is difficult. You'll need to assess the risks to make your own informed choice. But here's what I can tell you about how best to qualify for college financial aid.
Part of the decision would depend on what school your son plans to attend. As a high school sophomore, he might not know yet. Private universities may require you to fill out the CSS Profile versus the Free Application for Federal Student Aid, known as FAFSA. The two methods calculate financial need differently.
The CSS Profile, for example, considers the equity you have in your home, while the FAFSA does not. If you don't expect to fill out a CSS Profile, then prepaying your mortgage takes the money out of your savings or investment accounts for the FAFSA calculation.
A Section 529 college savings plan held in your name with your son as the beneficiary won't have much impact on your son's financial aid award.
If your son is the account owner and beneficiary, it's still reported as a parental asset if the student is your dependent. There are gift tax implications if you gift more than the annual gift tax exclusion of $14,000, or $28,000 if you and your spouse split gifts. You can contribute up to $70,000 as an individual and $140,000 as a couple and elect to treat the contribution as if it were made more than five tax years for gift tax reasons.
The downside of prepaying your mortgage with the idea of taking the money back out in three years is that you'll pay a new set of closing costs and interest rates could be higher three years from now.
Parental assets included in calculating the expected family contribution, in general, increase it by 5.64%. So, if you have $100,000 in home equity sitting in cash, it would reduce your expected contribution by $5,640 his freshman year. The impact in his sophomore through senior years depends on how much money you keep, if you took a cash-out refinancing after you filled out his freshman FAFSA, you would still have the funds affecting your expected family contribution in his sophomore, junior and senior years. Prepaying the mortgage would have a positive impact on the freshman-year financial aid package. But you would take on the interest rate risk as well as the expense of closing costs with a new mortgage.
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