The Sky-High Cost of College

Question of the week: As a new dad, I'm worried about paying for college for my baby daughter. It seems like tuition costs these days are astronomical. What should I be doing to get ready? —Sanji

Dear Sanji,

Your daughter should thank you for having such a long-term view about these things so early in her life. According to the College Board, today's average cost for tuition, room, board and books at a four-year private college is a cool $25,000 per year. For a four-year public school, it's a bit over $10,000. If you factor in inflation over the next 18 years until your daughter is ready for college, you could be looking at a total cost for four years of up to $300,000, depending on the kind of school she chooses.

Before you bite your fingernails completely off, you should know that there are things you can be doing to prepare for the bill for that bachelors degree in medieval studies. Here's some advice from parents in the Armchair Millionaire community who are successfully tackling sky-high college costs.

Save automatically. "We set up an automatic withdrawal each month from our checking account into our tax-deferred college fund—a 529 plan. We find that this makes saving fairly painless and ensures that we don't put it off. My parents also make annual gifts to our children's college fund for their birthdays." —LimaLiz

Start young. "When our son was born, we did some calculations that really motivated us. We figured out that if we started saving $200 a month immediately, we'd have almost $95,000 by the time he was 18. If we waited until he was 10, we'd have had to put away $700 a month just to get that same amount." —Barbary Jaspers

In addition, the folks in Washington, DC have created programs that make it easier to save by easing your tax burden. And each of these programs got a bit better with the recent changes in the tax law. Here's a rundown on your college savings options.

The Armchair Millionaire Summary of College Savings Programs

• Roth IRA. If you're funding a 401(k) or other plan for your retirement, a Roth IRA may be a good place for your college stash. As long as your distributions are used for qualified college expenses, the earnings in your account will grow tax-deferred. Starting this year, you can contribute up to $3,000 in your Roth IRA (if you fall under certain income limits), and that amount will increase over the next several years.
• State college savings plans. These are incredibly flexible plans with no income restrictions and very high contribution limits (over $200,000 per student in some states). You can contribute to any state's plan, regardless of where you live, and use the money to pay for any college. And beginning this year, withdrawals from these plans are exempt from federal tax. Many states offer a break on state income taxes, as well.
• Education IRA. Money in these accounts grows completely tax-free, as long as you use it to pay for college. You can now contribute up to $2,000 a year per child to an education IRA, up from a paltry $500. Anyone, like grandparents or that favorite uncle, can contribute on behalf of the child as long as they meet certain income limits.

The Bottom Line: You don't need a Ph.D. in Finance to send your kids to college. Start saving when they're young and take advantage of tax-favored savings programs. Investing in your child's future may be the smartest thing you ever do.

To Refinance or Not

Question of the week: With mortgage rates low, I'm thinking about refinancing. But I've heard that you have to reduce your interest rate by at least two points to make it worthwhile to refinance. Is that true?—Kim T.

Dear Kim,

These days, few things about mortgages are simple enough to be captured in any rule of thumb. Whether to refinance or not involves several things: How long do you plan to stay in your house? What's the length of time and interest rate on the new loan? How much will you pay in up-front costs? It all boils down to this: Will the savings from refinancing outweigh the cost of paying off your old mortgage and starting a new one?

It can be complicated. Fortunately, there are dozens of online calculators that will do the math for you. Check out different rate, fee and payoff scenarios to make sure you're getting the best deal. If your savings are greater than the up-front costs, refinancing can make sense.

Members of the Armchair Millionaire community have taken this trip before. Here's their advice on keeping your ventures into high finance as close to the ground as possible:

Check with your original lender first. "A lot of lenders have refinance programs for their own customers, so they require little or no documentation. Because my appraisal, income and credit information were already on file with my current lender, I didn't have to pay for these again."—James0111

Watch out for hidden penalties. "Be sure to check to make sure that your current mortgage doesn't have a pre-payment clause. Depending on how big it is, it could outweigh your savings from refinancing."—MariaH

If you decide to go for it, use my checklist to make refinancing as easy as possible.

The Armchair Millionaire Checklist for a Painless Refinance

• Get your paperwork in order. Have your most recent pay stubs, bank and investment statements and tax returns on hand.
• Be specific when shopping for the best rate. To be able to really compare two different loans, you have to know much more than just the rate. Also look at the term of the mortgage, discount points and the lock-up period.
• Understand the fees. These break out into three types: Lender fees (including charges for document preparation, underwriting and origination), third party fees (such as appraisal, title search and insurance, and credit report) and government fees (like recording taxes and other charges assessed by local or state agencies).
• Get a Good Faith Estimate of costs before committing to anything. Don't hesitate to question any fees that seem out of line. If a potential lender insists on sky-high fees, take your business elsewhere.

THE BOTTOM LINE: Interest rates are lower than they've been in a long time. Refinancing can save you thousands of dollars over the next few years. On the other hand, a bad deal can cost you more than you save. Do the math and you'll surely come out ahead no matter which path you choose.