Fund college through Home Equity Loan or by Cashing in Investments?

[Ms.Quickstep]

Hello, I'm new to Mr.MoneyMustache, and have been avidly reading my way through it. I don’t want to risk having missed something!

I have a situation that is somewhat unique, or at least, I haven’t yet seen it discussed, and I would very much appreciate your sage advice. Here’s the background: we are a family of five – husband in early 60’s, wife in late 50’s, and 3 sons in college.  Husband has always had his own business , wife worked PT during children’s formative years, and currently works FT, with wages of $60,000 plus 10% employer contribution to retirement fund, and 100% employer-paid health insurance premiums. Up until 2008, our family lived under our means and managed to save over $400,000 in retirement funds, $300,000 in investments, and $70,000 in accounts earmarked for college. However, in the perfect storm of 2008, Husband’s business income (which in a good year netted 60,000 plus) began to drop precipitously and leveled off by 2012 to an annual net of $22,000, Child #1 entered college (followed by Child #2 in 2009 and Child #3 in 2012), AND (here’s the real kicker) Husband borrowed $150,000 from the home equity line of credit to cover stock market margin calls.

Fast forward to 2013: for the past five years, we’ve been paying the interest and a small amount of principal on the HEL ($425/month), and Husband makes occasional large deposits and/or withdrawals from the HEL (from stock market gains or losses), but the median balance always seems to be $150,000. The college accounts have been depleted to pay for the first several years of college.  The retirement accounts have grown to about $500,000, and the investments to about $500,000. However, between the college expenses and decreased income, we will be running at a deficit for the next 3 ½ years.

Here’s the question: is it better to fund that deficit through additional loans from the HEL (3% interest) or by cashing in investments? And, how are we ever going to pay down the HEL except by cashing in investments? Am I even asking the right questions?

Other relevant financial information: mortgage is $130,000 and since 2 of the college aged kids are still living at home, don’t want to sell/move until they are out of the house. Annual expenses (not including college) are currently $74,000 (yes, I know we're not yet Mustachians). College expense will be $38,000 for 2013, $52,000 for 2014, $35,000 for 2015 and $35,000 for 2016. Yes, we (Mom & Dad) are footing the entire bill for college, but since that’s the precedent we set with Child 1, it doesn’t seem fair to change the rules mid-way for Children 2 & 3.

Thanks in advance for your thoughts.

[The Bearded Bank Builder]

Hi Ms.Quickstep,
My initial reaction is to suggest that you pay for college through the HEL, but it depends on your comfort level of having debt balances. From a strictly mathematical standpoint, you can assume your investments will earn significantly more than 3%. So, if you are fine with having debts, the best thing to do would be to keep making small payments and paying the 3% interest and let your investments continue to grow.

It's up to you though. If you prefer to have your debts paid and have that monthly payment eliminated, then that's the way to go. If you strictly want your money to be spent in the most efficient way possible, pay for college with the HEL.

[tooqk4u22]

My suggestion is to first apply for student loans and get the max. (1) Relatively low cost, (2) your house isn't at risk, (3) the kids can always pay it as it is for them, (4) you can alwayst decide to pay it off for them later. 

With that spending level and those debts at your ages I think more attention should be paid to your financial plans ahead of your desire to pay for their college.

[Catbert]

Yep, have the kids get student loans. 

You also gotta get your husband to quit playing the stock market on the margin!

[tooqk4u22]

You also gotta get your husband to quit playing the stock market on the margin!

Maybe but there is nothing inherently wrong with it but the common folk shouldn't be doing it - keep in mind that if one has any debt including mortgage and is investing they are essentially doing so on margin.

[Ms.Quickstep]

Thanks for these thoughts. Continue to send them my way!

[SunshineGirl]

This is a tough one for me to offer advice on. At first glance, an option that really simplifies things would be is you took some of your investment money and paid off your HELOC. Maybe even your mortgage, too. Then, get your expenses down. They're insane!

-- Why don't you post and ask for advice in creating a plan to get those under control? A mortgage of $130K can't cost all the much, so where is your money going?
-- What is your home worth? Currently, you owe $280K against it. What are your plans for once it's just you and your husband - do you plan to downsize?
-- I'd certainly mention to my kids that if they wanted to take a semester off and work, that would be welcome. It's not just them contributing, but it's the cash flow and spreading out the payments that might help. On the other hand, might having three in college at once with your income enable you to get grants??
-- Can your husband get a job with benefits? It would be great if he could for a couple years. Even a PT semi-retired fun job.

Good luck.

[Ms.Quickstep]

When the kids are out of college and out of the house, we can downsize and decrease our expenses. Here are just the expenses related to where we live (and believe it or not, this is a "deal" compared to other homes in our neighborhood and other neighborhoods in our metropolitan area):
Mortgage: $15600 (house is valued at about $600K according to Zillow)
Property tax: $12000
HEL payments: $5100
Utilities: $3200

Other expenses that aren't going anywhere under our current scenario:
Payroll taxes: $9000
Contribution to 401K: $7500
Medical (2 people with ongoing medical issues/meds): $2700
Gas/repairs on 2 vehicles (5 year old compact, 12 year old minivan, 20 mile roundtrip commute to work daily, 2 kids sharing other vehicle to drive to their classes): $3600

In terms of the kids taking time off, we actually get a higher level of financial aid because there are three of them in college currently. And, the college expenses mentioned previously are out-of-pocket after grants, scholarships and maximum student loans that have been offered.

Husband is not willing to either give up trading on margin (he's SURE he knows how to plan that game) or find a job. After 30+ years of working for himself, he doesn't have the skills or interest to work for someone else.

As a newbie-wannabe Mustachian, I can see the error of the many choices that were very non-Mustachian, and that's why I'm seeking the counsel of more experienced Mustachians to figure out where to even start or what questions to ask.

[Done by Forty]

It's possible that the business is simply paying for losses from playing the market, meaning two jobs for no money. 

The big, juicy fruit in your budget is the house.  Selling and renting (ideally, very close to work) could be a huge benefit, depending on what rents go for in such a neighborhood.

[Another Reader]

In my opinion, your description of your husband's behavior makes him look like a compulsive gambler and someone unable to back away and do the right thing for his family.  He ran up a margin debt of $150,000 on a $22,000 income.  That's a pretty good indication of compulsive, irrational behavior.  In your shoes, I would think about separating finances to protect what I could for my future.  If the house is in your name as well as his, I would not sign any other paperwork to allow him to borrow more against the house.

[unpolloloco]

Looks like you're at 1M+ in retirement+investments right now (not counting the equity remaining in the house or any business value), which really sets you up well for retirement (assuming a move, given the fact that housing is currently >1/3 of your budget).  Selling the business and house might net you about enough to live on if do you did it right now.  Also, with investment gains, you're likely to see net worth appreciation even when you're spending more than you earn (assuming the market doesn't go down).  Even with the margin call, you still have had net worth appreciation since 08.

Is there any potential to increase revenue for the business?  Would make it worth significantly more come time to sell it.

Also, if you moved right now to a lower cost area, would the property tax reductions be enough to pay for rent for your kids?  Also, can you ask kid #1 to contribute a few bucks towards the educations of kids #2 and #3?

Margin investing might make some sense if you weren't so close to retirement.  Not now - you need to be paring down the risk in investments.  Margin investing does have high potential for returns, but is proportionally riskier, not a good thing for someone thinking of retirement soon.

[Ms.Quickstep]

Wow, many excellent responses and food for thought. In answer to some of them:

The business doesn't really have any value, so I don't believe anyone would buy it. At various points in time, I had hoped that perhaps one of the kids would take it over, but none are interested, and it would need a complete business-model makeover to be viable.

Once one or two kids leave the house, downsizing and moving closer to work would have a huge positive financial impact (including paying off the HEL and putting an end to the margin calls). That's 6 months to 1 1/2 years away.

Back to my original question (since next tuition payment is due in 3 weeks): better to cash in some investments (primarily municipal bonds) or to pay tuition through the HEL at 3%?

[Done by Forty]

If the bonds aren't paying 3%, then the math says to use them.  If the investments pay more than 3%, then use the HELOC. However, that analysis doesn't include third and forth options. 

Moving (or finding some other way to lower monthly expenses, or raise income, etc.) would allow you to use fewer investment dollars (or borrow less) for college.

[Ms.Quickstep]

Understood. And thank you all!