Q. I have to pay off $18,000 of credit card debt. I currently save $500 a month to a 529 plan for my high school junior. We will need to borrow additional money. Should I stop the college saving and pay off the credit card faster?
A. Congratulations on choosing a 529 plan to save for your child’s college education.
529 plans are a smart choice and offer one of the most powerful and flexible ways to save for school.
That said, your question really boils down to whether you’re better off borrowing from your credit card company to finance your child’s college education versus taking out student loans to do so.
“By carrying a balance of $18,000 on the credit card, you’re effectively borrowing money at a very high rate of interest to finance your investment in the 529 plan, which almost certainly won’t earn the same rate of interest, even with its tax-free advantages,” said Gene McGovern of McGovern Financial Advisors in Westfield. “For that reason, the answer in virtually every case is that you’re better off paying down the credit card balance faster.”
You’ve said that you’ll need to borrow money for your child to attend college, even with the 529 plan savings. Many students do, McGovern said, and borrowing for education, if done wisely, is a good investment. On average, college graduates earn 56 percent more than high school graduates, he said.
Virtually any education loan, whether you or your child is the borrower, is likely to have a substantially lower interest rate than you are currently paying on the credit card.
For example, he said, direct federal student loans for undergraduates currently carry a fixed interest rate of 3.76 percent while the national average credit card rate, which is often variable, is just under 16 percent.
“Student loan interest is also tax deductible up to $2,500 per year, whether or not you itemize deductions,” McGovern said. “Credit card interest isn’t deductible, so the difference in interest costs is even greater.”
Your $18,000 credit card debt, at 16 percent a year, could be costing you about $2,880 in interest per year, McGovern said. Redirecting the 529 contributions to paying off the balance would substantially reduce that cost.
The short answer: Stop the 529 contributions, pay off the credit card, and take out student loans as needed.
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