Pay off debt as top priority

PERSONAL FINANCE

Your Money

August 15, 2006|By EILEEN AMBROSE | EILEEN AMBROSE,SUN COLUMNIST

Two worthy financial goals. Which to tackle first? That's reader George Bell's predicament. He recently finished a doctoral program in Chicago and is returning to Baltimore. The 29-year-old wants to save for a down payment on a house, but he wonders if he would be better off first repaying $20,000 in student loans at a high interest rate of 9 percent.(He has another $150,000 in student loans, mostly from graduate school, but has consolidated them to lock in a rate below 3 percent.)

Bell e-mails: "Is it better to save $20,000 over the next year for a down payment realizing I will pay more for my loans in the long run, or is it better to pay off the loans and sacrifice the down payment for a house?"

If it must be one or the other, financial advisers recommend paying off the 9 percent loans.

That's like earning a 9 percent return on money, says John Bacci, a financial planner in Linthicum.

If Bell saved for a down payment, he would probably earn 4 percent on his savings account yet be paying the 9 percent rate on his debt, Bacci says.

There's no tax break on the 9 percent loans, either, Bacci notes. Taxpayers can deduct student loan interest, but Bell already exceeds the $2,500 deductible limit with all his other outstanding loans.

"Nine percent non-deductible debt is pretty brutal," Bacci says. And once Bell reduces his debt, he'll look more attractive to mortgage lenders, Bacci adds.

Columbia financial planner J. Michael Martin agrees the high-rate loans are corrosive. And he says Bell shouldn't rush into the real estate market fearing that prices will soon be out of his reach.

But Martin suggests a compromise. He recommends that Bell put $10,000 toward paying off the high-rate loans and another $10,000 in savings for a down payment. The next year, he should do the same.

"In two years, you have no $20,000 loan and have $20,000 for a down payment," he says.

The housing market might be more favorable for buyers then, too.

And without the loans, Bell will have more money available if emergencies crop up in his new home, like the furnace needing replacing, Martin says.

Gaithersburg financial planner Christopher Brown says Bell shouldn't assume that he can't achieve both goals at once. Brown recommends that Bell visit a mortgage consultant once he returns to Baltimore to learn about his mortgage options or programs for first-time homebuyers.

529 college plans

The tax fate of 529 college plans is no longer in doubt. The recent pension bill passed by Congress makes permanent tax-free withdrawals from college savings plans and prepaid tuition plans - both called 529s after the tax code creating them - if the money is used for college. This tax break was set to expire after 2010. That gave some families pause.

"There were worries about the treatment of 529s after 2010. In all the program materials, there is an asterisk. It confused and concerned investors," says Joseph Hurley, a 529 expert and founder of Savingforcollege.com.

In an online poll last year by Hurley's group, 51 percent of the 938 respondents said they would put more money in a 529 plan if the tax break was made permanent.

So far, more than $90 billion has been invested in these plans for more than 9 million students, according to the College Savings Plans Network.

Questions? Comments? Write personal.finance@baltsun.com

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