Q: I had to take out a very large loan to pay for one year of my son’s college tuition. I anticipate it taking a minimum of 5 years to repay. I am also repaying a HELOC loan. What is the best way to handle this? Should I payoff debt or save money for retirement?
Should I try to pay them off as quickly as possible reducing the money I would put aside for savings, or do I pay what I can and make savings a priority? I have a bit put aside for emergencies, but nothing substantial.
A: This is a classic case of “which should I do first – pay debt or save more”? The answer isn’t really a matter of either/or. It’s a question of how to do both simultaneously because that’s the best approach.
You need savings to avoid going into debt. After all if you don’t have a cash cushion, the slightest emergency – like a flat tire or a leaky roof – will send you heading for your credit cards. Also, you should pay off debt as soon as possible because you don’t want to pay unnecessary interest charges and be prevented from saving money for other future goals.
The good news for your situation is that both of the loans you’ve taken on – school debt for your son, and a home equity line of credit – carry relative modest interest rates. You didn’t say when you got your HELOC, but I assume it’s in the single digits (i.e. less than 10%, and probably significantly less if you got the loan in the past couple years). Ditto for that student loan.
So divvy up the available cash you have and work at meeting both objectives: knocking down that student loan balance and your HELOC and also adding consistently, month after month, to your savings nest egg. If I had to prioritize, I would say slash that HELOC debt first and put more emphasis on that than the student loan debt.
If it’s a federal loan, the student loan debt may be subsidized (meaning the government is paying the interest on the loan while your son is in school). Lastly, because the healthcare reform bill recently signed into law by President Obama includes student loan reform as well, you can expect college loan costs to come down significantly.
For instance, starting in 2014, student loan repayments will be capped at 10% of a borrower’s income. That means even if you can’t pay off that loan in five years, your son can start working on it — and it’ll be relatively affordable for him to do so.
