How to Turn Your Mortgage Into a College Savings Plan
A “529 Plan” is a popular education savings plan designed to save money for college expenses. Operated by an educational institution or by a state agency, they offer the benefit of tax deferred investment growth much like a retirement plan. Additionally, withdrawals for qualified educational expenses are tax-free. Finally, even though your contributions are not tax deductible on your federal return, you may be able to take a deduction for state income taxes.
While 529 Plans have many benefits, they are not without limitations. Contribution caps and restricted investment options reduce the benefits for some people, especially if they don’t start saving early enough. However, there is another option you can take advantage of that often allows you to save more money than a 529 Plan.
You can turn your mortgage into your own college savings plan by putting the contribution instead towards your mortgage. Rather than growing a 529 Plan balance, you reduce the amount you owe on your house and the savings are surprising compared to a 529 Plan.
If you are a year and a half into a 30-year mortgage with an interest rate of 4% and an original loan balance of $275,000, you still owe about $268,000. You could refinance that balance to a 15-year loan at $3.5% and have a payment $603 more per month. Over 10 years, your loan balance will be $100,401 lower.
If you have a 529 Plan and contribute of $603 per month with an annual rate of return of 5%, in 10 years, you will only have $91,014. You would need a rate of 7.1%, to have $100,449 after 10 years, matching the above scenario. However, if the return drops to 3.00%, then you only have $82,953.
Even if you have a lower rate on your current mortgage, you will likely save more. If you take that same $600 per month and put it into your 30-year mortgage with an interest rate of 3.75%, you still save over $87,000 in 10 years.
The contribution to your mortgage creates several other advantages as well. While the contributions to a 529 Plan are tax free in many states, that may not save you much depending on your income and the state in which you live. Meanwhile, the savings on your mortgage are tax free, guaranteed no matter what happens to the stock market or interest rates, offer no contribution limits, and the savings can be used for anything you want without penalty. Additionally, you will owe less on your house and the savings on interest alone may reduce your tax deduction (if they don’t get rid of that!).
In the end, your comparison depends on your unique financial situation, where you live, the estimates you use for the rate of returns on the 529 Plan, and changes to tax code. I simply want you to think of different options to meet your financial goals and show you how my clients achieve their goals in different ways.