Pay Off Your Mortgage or Save for College?

As the song in Cabaret goes, money makes the world go round. But there never seems to be enough of it. There’s always something. Parents are faced with all sorts of choices when it comes to household finances. One is: Should you pay off your mortgage or save for college?

How Do You Prioritize?

One couple has asked CNNMoney’s Broke No More blog this precise question:

“Our only debt is our home mortgage. We have 19 years left if we continue making payments as scheduled. I’m anxious to pay it off sooner, but also need to save for our kids’ college (4-year-old and 2-year-old). Should we put 100% of our focus towards our kids’ college, and ignore the mortgage? Or 50/50? Or knock out the mortgage as quick as possible and then ramp up college savings?”

How does someone decide to pay off your mortgage or save more for retirement or save for kids’ college? Is it always wise to try to pay off a mortgage as quickly as possible? Why or why not? How may life circumstances differ for each person who is having to prioritize mortgage versus retirement versus other saving? (For related reading from this author, see: Is It Ever Too Late to Start a 529 Plan for College?)

Prioritizing Retirement Savings

As a financial planner with a college and retirement planning focus, I would say that a top priority is not paying off the mortgage but 1) saving for retirement and 2) saving for college in that order.

If the children here go to a school requiring CSS Profile financial aid forms, home equity may be counted. For FAFSA schools, it does not. So, the home equity could pose a stumbling block toward needs-based financial aid.

If you have that much discretionary cash flow to pay off your mortgage, you really ought to focus on retirement first. Why? One can always borrow for college but you really can’t borrow for retirement (aside from a home equity conversion mortgage but that’s a different discussion).

Since most folks typically get a new mortgage once every seven years - sometimes because they move, sometimes because interest rates have dropped and sometimes to fund needs like home improvement or college - you may as well find a better, higher return for that extra cash for your other priorities because you’re very likely to end up refinancing anyway for Johnny and Jane’s college years.

So, most are probably better off setting aside the same amount they want to prepay in a savings/investment account which they can accumulate and then decide to lump sum pay toward the mortgage or to college or for retirement, etc.

Also, retirement funds are not counted by either. Neither is life insurance. So, these folks are probably like many and may also have a life insurance need. While term makes the most sense most of the time, if they wanted to shift to funding a cash value policy, they would have a resource that could possibly be tapped tax-free for college or retirement. With this much runway before college, a cash-value type life insurance policy has time to "grow" and absorb the typical costs of a policy over several years.

And you’ll want to fund retirement accounts as much as possible before financial aid forms need to be filed since amounts contributed in the year they file FAFSA or profile are added back as income available for college. Also, most folks keep a mortgage for seven years on average.

Bottom line here: Best to do a long-range college funding and tax plan to work out the details. No client of mine has ever said that they wished that they started planning later. (For more from this author, see: How to Pay for College Without Lots of Debt.)