Using ARM loan is better than 401k to pay for college.
Q: My husband and I are 56 and 55 respectively. We have 3 college tuitions and 2 of 3 weddings done, and are now thinking of taking advantage of the great prices for a vacation condo.
We have enough cash for the 20 percent down payment, but won’t have the full amount until we reach 59 ½ and can cash out some of our investments. We both have 401(k)s, and full pensions when we retire.
We first thought about taking an early withdrawal, but decided against that with all the penalties and taxes. We are now thinking in terms of a 5/1 adjustable rate mortgage (ARM) and paying it off when we reach the age where we can withdraw without penalty.
Is this a good idea? Do you have any other suggestions?
A: I think borrowing money at today’s historic low interest rates is a very good idea. You’ll need at least 20 percent down to get the best interest rate, and you can decide if paying 4.5 percent is a smart move or if you’d prefer to pay off the property over a few years once you have access to your 401(k)s and pensions.
Saving for college is a hard thing to do given the high cost these days and the annual escalation in those costs. But interest rates on fixed term mortgages is low and interest rates on adjustable rate mortgages (ARM) are even lower.
Prices are extremely cheap in some second home locations and there are loads of foreclosures, some of which might be well worth a look in terms of value. I’d try to buy something cheap, but that will sell fairly easily in 5 or 7 years in case your plans change.
We’re not recommending 5/1 ARMs at the moment, simply because the fixed interest rates are so low. The best choice at the moment is a 15-year loan, if you can swing the payments. That will allow you to take advantage of even lower interest rates.
This way, if you decide to keep the loan, you know you’re protected against higher interest rate swings. (I recently refinanced to a 15-year at 3.25 percent, but the interest rate on a vacation home might be slightly higher.)
One option would be to refinance your primary home (I assume that is paid off) to a 10-year mortgage. Right now, those interest rates are hovering around 3.25 percent (or less). It’s a great way to lock in a super-low rate. Essentially, you’ll only be paying principal with very little interest in each payment.
I’d run some numbers and then talk to at least 3 or 4 different lenders to get an idea of what it will cost you to finance this property. If your vacation destination is in another state, consider speaking with a lender that is local to that area. You’ll want someone on the ground who really understands what happens locally.
My personal finance advice has always been to avoid the fees and penalties on a withdrawal from a 401k plan if you have other alternatives. If one of those alternatives is a low interest loan such as a fixed rate mortgage or ARM mortgage, you’re better off. And in many cases the interest payments on those loans will be tax deductible.