Cash-out Refinancing to Pay For College

You've got a bright kid. She worked hard for her grades, aced her SATs, and now she's been accepted to Trinity and Sarah Lawrence. While she's busy evaluating which dorms have the best amenities, you need to figure out how to pay for everything. The answer may be closer than you think.

Finding funds

Begin by taking advantage of all the scholarships and federal loans that are available to you. Nothing beats the generous terms and low interest rates on Perkins and Stafford loans. But they go only so far.

The next step is to review your home mortgage loan. It may be time to refinance into one with lower rates or better terms. This could give you the opportunity to secure funds for your star student, as well.

A cash-out refinancing = home equity back in cash

A cash-out refinancing gives you some of your home equity back in cash, which can be especially tasty if home values have skyrocketed in your area. But there are a few issues to consider if you're going down this avenue.

One of the best perks of a mortgage refinancing is the ability to deduct some, or all, of the interest from your income taxes. If you're in the 28 percent tax bracket, the deductions can effectively knock a quarter point of interest off a 7 percent loan. In other words, it will cost you as much as a 6.75 percent loan with no tax advantages. There are limits to how much you can deduct, however.

What to remember with a home refinancing

To take the greatest advantage of the tax code, the cash-out sum should generally stay below $100,000. If the school that you choose isn't quite that expensive, you can use the equity for any of your other needs, as well. Home improvement costs always have fully deductible interest, so this could be a good time to remodel the kitchen or replace those old carpets You should park any excess funds in a liquid account until you need them.

The cash you receive from your mortgage refinance will come as one lump sum, but college is a multi-year project. So, make sure the money is placed in a safe investment that can, at least, keep up with inflation. Short-term CDs (up to three years) can be effective options, and treasury bills represent the ultimate in safe investments. The idea is to keep your money safe until it's needed, and maybe grow it a little bit in the meantime.

Finally, if you don't need all the money you can get out of your refinancing, don't borrow it at all. A dollar not borrowed is a dollar not racking up interest and raising your monthly bill. And if your home pays for college, your child will have a whole new appreciation for that old house she grew up in.