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My cabdriver Manny was very happy to have a money expert in his car, as he had a few questions for me, but he was even happier that I shared a heritage with his daughter who was in high school and getting ready to apply to colleges. I was thrilled for him and his daughter. But he burst my bubble when he told me how he was going to pay for school: He was going to mortgage his house! He was going to take every bit of equity out of the house that he and his wife had been paying a mortgage on for 20 years to pay his daughter's tuition bills.
I asked him to pull over, meter running. "What kind of retirement savings do you and your wife have?" I asked. "Not much," he answered. I told him, "I want you to encourage your daughter to go to school, even help her a little bit with money, but do not mortgage all the equity in your home for her tuition. Your daughter has many more years to pay off student loans than you and your wife have to pay off that new mortgage."
For many people, it's understandable and normal to throw everything you can at your kids so they can go to college and get that degree. After all, they'll take care of you when you get old, right? And what about after college? Does financing your kids end there? Well, we may all wish that's the case, but the reality is that with an unemployment level twice as high as the general population, 20-somethings are coming back home to their parents in record numbers, and rarely at no cost.
The Real Cost of Manny's Plan
If Manny takes out a 30-year, $80,000 mortgage on his home at 5.5 percent (leaving $40,000 of the original mortgage scheduled to be paid off in 10 years), he and his wife will have $454 a month going toward debt instead of saving for their retirement. They will turn an asset into a liability that will cost a lot more than what they're currently paying in interest. They could have been mortgage-free in 10 years; now they won't be even halfway done paying off this new mortgage in 20 years.
Sure, we can hope that the value of their home will grow and that they could even sell in 10 years for a profit, but then what? Would they buy again or rent? Being without a mortgage or housing payment in retirement is very helpful to your bottom line and ability to maintain your quality of life. And for Manny, with very little in retirement savings, if he still has a mortgage in 25 years, he won't be able to stop working, and he'll be 75.
What Manny Could Do
What if, instead, Manny's daughter goes to a lower-cost public college for two years, transfers to a higher-cost private school that she prefers, applies for aid and work-study, and then takes out federal loans totaling $20,000 at a fixed 4 percent?
All the while, her parents, instead of mortgaging the house, let her live at home for the first two years that she goes to a local public college, then send her $200 a month for cash expenses or agree to pay for her books, cafeteria and cell phone until graduation.
Her parents would still be out a couple hundred dollars a month in support, but there would be no interest, the mortgage would be paid off on schedule and they'd still be able to save for retirement ($200 a month at 7 percent growth for 20 years comes out to over $105,000). She would have a loan to pay off, but one that garnered her better pay because it was attached to a college degree; plus she'd have many, many years to pay it off.
When the Cost Is Just Too High
The cost of crippling your retirement plans for your adult children, whether it's overleveraging yourself to pay for their education or handing over assets to help pay off their debts as adults, can be too high. It's too high when the cost of helping jeopardizes your finances and your future. Of course, if a child is sick or there's an emergency, we'd all mortgage ourselves silly to help, but there are other ways to help able-bodied, educated adult children who may just be in a rut without paying too high a price.
Don't Enable. Able
Know when you've got a moocher. If it's a cell phone bill or a student loan payment and you know that your child has a job, goes out with friends frequently or even travels, say no. "But their credit will be ruined!" you might argue. That's life. Sometimes the best way to learn is through experience. If there are no consequences to not having a budget or spending mindlessly, then nothing will be learned.
People go through hard times and it's understandable that sometimes they really need your help. If you're financially secure and your kid is having a hard time finding a job or has been laid off, help, but with boundaries and limits. Agree that he can live with you, rent-free, for one year. If he finds a job before that one year, he can contribute to the grocery bill (and, always, to keeping the house in order). If you're paying their student loan bills, give them a time limit as to how long you'll do so.
Formal Agreements for Big Loans
Some kids need help with a down payment on a home; actually, more and more kids do since more people are entering adulthood with debt. But few of us can part with a five-figure sum as a gift. Set a time frame and a payment schedule as well as a generous interest rate (up to you if you want to make it low and friendly, like 2 percent, or a market rate like 6 percent or more). You may be lower on their totem pole of debt as other debts will surely have higher rates, but getting them on a schedule means fewer arguments, a return of your loan and a limit on the difference between the interest they're paying you and what you'd be making on that money elsewhere.
From the book The Real Cost of Living: Making the Best Choices for You, Your Life and Your Money by Carmen Wong Ulrich (Perigree).Copyright © 2011.
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