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When Should You Consider Bankruptcy & How to File

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Updated – November 14, 2018

If you’re drowning in debt and having trouble keeping up with your payments while still handling your living expenses, you may have at least begun to consider filing for bankruptcy.

Filing for bankruptcy is meant to give people in serious financial distress some relief and a chance to start over. By the time most people get to that point, they’ve probably tried many other methods for managing their debt.

Bankruptcy certainly has its benefits, potentially allowing you to wipe the slate clean and start anew.

But there are a lot of things to consider before making a decision, from the negative consequences of filing to whether bankruptcy would even provide relief for your specific situation.

“For most folks that come in, this is the last option,” said John Colwell, a San Diego, Calif.-based bankruptcy attorney and President of National Association of Consumer Bankruptcy. “I know I’m like the dentist. People really don’t want to be sitting in front of me.”

This is a big decision that requires a significant amount of due diligence before moving forward. While it’s important not to take bankruptcy lightly, it may be the best way for people to get back on their feet.

So how do you know if bankruptcy is the right way to relieve your debt? In this post, we’ll go over some of the key points to help you get started.

The basics of filing for bankruptcy

Bankruptcy is a legal procedure to discharge debt built up by someone who either will not be able to repay those debts or does not have the means to repay debts owed currently. There are two notable forms of bankruptcy: Chapter 7 and Chapter 13.

In a Chapter 7 bankruptcy, a debtor’s nonexempt assets are sold and the proceeds are used to pay debts. An individual must pass a means test before they can file a Chapter 7 bankruptcy to ensure that the court would not be abusing the bankruptcy law by granting one. We will talk more about the means test below!

A Chapter 13 bankruptcy is a “wage earner plan.” To qualify, an individual must have a steady income. This allows them to pay back all or part of their debts by developing a repayment plan. The plans last between three and five years.

In most cases, bankruptcy does not protect you from any future debts incurred. It also will have an effect on your credit score and remains on your credit report for 10 years with Chapter 7 and seven years with Chapter 13. In a Chapter 7 bankruptcy, you may lose assets such as your house or your car depending on how much equity, if you’re able to exempt your equity and if you’re current on your payments.

Are You Eligible?

As stated above, there are two types of bankruptcy for individuals: Chapter 7 and Chapter 13.

There are some significant differences between the two programs, but here’s a high-level summary:

  • Chapter 7 allows you to completely discharge your debts, with some exceptions (such as student loans, certain tax obligations, and child support). But you may be obligated to sell some of your property to settle some of your debt obligations.
  • Chapter 13 allows you to create a payment plan to repay some or all of your debts over a 3-5 year period. So your debts are not discharged, but you will also not be obligated to sell any property in order to make your payments.

Either one could be more or less beneficial depending on the specifics of your situation. But the very first question is whether you qualify for either one, and each has its own set of criteria.

Chapter 7 bankruptcy has what’s called the “means test”, which is meant to ensure that only people who truly can’t afford their debt payments are allowed to file. There are two different wants to pass it, and therefore qualify for Chapter 7 bankruptcy:

  1. If your monthly income is less than the median monthly income in your state for your family size, you pass. You can find current median income numbers by family size here.
  2. If you don’t pass #1, you’ll have to go through a complex calculation to see whether your disposable income after subtracting out certain expenses is enough to satisfy your debt obligations. At this stage it would probably be best to talk to a professional who could help you navigate the process.

Eligibility for Chapter 13 bankruptcy is a little more straightforward. Here’s how it works:

  1. As opposed to Chapter 7, you need to prove that your disposable income is high enough to afford a reasonable repayment plan.
  2. Your secured debt (mortgage, auto loan) can’t exceed $1,149,525, and your unsecured debt (credit cards, medical bills, etc.) can’t exceed $383,175.
  3. You must have filed both federal and state income taxes each of the last four years.

There are some other requirements for each, but those are the major ones. Assuming you qualify for at least one of them, there are a few other things to consider.

What Kinds of Assets and Liabilities Do You Have?

Depending on the specifics of your financial situation, one type of bankruptcy may be preferable to the other. Or it may be that neither would actually be particularly helpful.

As an example, neither type of bankruptcy would likely help you all that much if your primary debts are student loans. They wouldn’t be discharged in Chapter 7 bankruptcy. And while your required payments might be reduced over the 3-5 year repayment period in Chapter 13 bankruptcy, once that was over you would have to continue paying them back as usual.

The type of assets you own and their value also matters, particularly if you’re going through Chapter 7 bankruptcy. During that process, your bankruptcy trustee is allowed to sell your property in order to settle your debts, but certain property is protected.

For example, your house and car are protected up to certain limits. Employer retirement accounts like 401(k)s and 403(b)s are fully protected, while IRAs are protected up to about $1 million. But other accounts, such as checking, savings, and regular investment accounts may not have the same protections.

The rules here vary by state, and having a strong understanding of which assets you might be able to keep and which you might end up losing will help you make your decision.

When to file bankruptcy

According to Colwell, filing for bankruptcy needs to be “worth your while,” meaning it should give you relief from your debts to ensure you don’t find yourself in a similar situation in the near future. That means that if you have major expenses that you are about to incur, you should wait to file until after you have incurred them so they can be included in the bankruptcy settlement. This is especially important when it comes to filing bankruptcy due to medical bills.

However, with a Chapter 13 bankruptcy, you can seek court approval to include new debt that you’ve incurred post-filing into your payment plan.

In general, though, there are aspects of your financial situation that signal when it’s time to consider bankruptcy. If you can’t pay your bills (and you don’t see that changing anytime soon) and your debt continues to pile up, bankruptcy is probably worth considering.

Here are other red flags to look out for:

  1. Debt collectors are calling. If you’re behind on your bills to the point that you’re hearing from debt collectors, it may be time to consider bankruptcy. This is especially true if you’re being sued by debt collectors.
  2. You’re in danger of losing your home. If you’re at risk for losing your house to foreclosure, filing bankruptcy can help you get caught up on your payments and keep your home. With Chapter 13, you’re given the chance to keep your home by creating a plan to repay your outstanding debt.
  3. You’re using loans to pay your bills. Using short-term high-interest loans such as payday loans can get you in trouble. With these loans, people borrow against their next paycheck. “People get caught in the trap and it starts rolling over from paycheck to paycheck to paycheck,” said Colwell. Title loans are another form of small loan where a vehicle is used as collateral; these loans can be problematic for someone already in financial distress.
  4. You’re liquidating your retirement assets. Retirement money is exempt in a bankruptcy, meaning trustees can’t use it to repay lenders. So in most cases, it doesn’t make sense to burn through your retirement money to pay debts. “I hate that with a passion,” Colwell said. “It’s your retirement money, what are you doing?!”

How to file for bankruptcy

Most initial consultations with lawyers are free of charge. At these meetings, you’ll walk a bankruptcy attorney through your financial situation and your reasons for wanting to pursue bankruptcy.

There are also ways for individuals to file for bankruptcy on their own, known as filing pro se. Court employees and bankruptcy judges can’t give out legal advice to people in their courts, so if you go that route, you will be on your own. To file yourself, you should be familiar with the United States Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and the local rules of the court.

Unless you have a strong understanding of legal issues and have the time to handle the paperwork, it’s probably best to use a lawyer — that’s because making a mistake can impact your rights, according to the U.S. Courts. You’ll also need the capacity to fill out a lot of paperwork, Colwell also noted.

If you use an attorney, they should be able to provide services including:

  • Advising you on whether to file a bankruptcy petition and under which chapter to file.
  • Telling you whether your debts can be discharged.
  • Advising you on whether or not you will be able to keep your home, car, or other property after you file.
  • Advising you of the tax consequences of filing.
  • Advising you on whether you should continue to pay creditors.
  • Helping you complete and file forms.

How to file Chapter 7 bankruptcy

A Chapter 7 bankruptcy involves the sale of all of your nonexempt assets to pay back your creditors. This is the most common kind of personal bankruptcy, accounting for more than 60 percent of all non-business bankruptcies in 2017. The process usually takes about four to five months.

Filing for Chapter 7 will wipe out your allowable debt (such as as credit card, medical and personal loan debt), but the bankruptcy will remain on your credit report for up to 10 years.

The first step is to take a mandatory credit counseling course from a government-approved organization, within 180 days of your filing date. Upon completion, you can decide if you still feel it appropriate to move forward with a bankruptcy, and move on to the next step.

At this point, you, or your attorney, would file your petition and other additional forms with the court. Along with your filing petition, the forms include a list of your creditors, a summary of your assets and liabilities, lists of property (both exempt and non-exempt) and any documentation needed for your “means test.” There are also companies that will send you a packet of all relevant documents, for a small fee.

At this point, you will be subject to the “means test.” If the debtor’s current monthly income is more than the state median, the means test is applied. Abuse is determined if the debtor’s monthly income over five years is either more than $12,850, or more than 25% of the debtor’s nonpriority unsecured debt of at least $7,700.

A trustee is then appointed to review the paperwork and take nonexempt property; you will also have to submit your most recent tax return to the trustee.

The next step in the process is a meeting of creditors, known as a “341 meeting.” At the meeting, you will answer questions about your finances and bankruptcy forms under oath. Creditors are allowed to attend the proceedings if they choose.

It is now decided if you are eligible to file for Chapter 7. At this stage, secured debts are determined: they can be repossessed by the creditor, you can redeem it by paying back what it’s worth or you can reaffirm the debt, which removes that debt from the bankruptcy filing and allows you to pay it back when the bankruptcy is over.

You will have another course to attend that will include information on developing a budget, using credit and managing money — afterward, your debt will be discharged.

Cost: A Chapter 7 bankruptcy needs to be paid for upfront by the debtor. It is generally a flat rate and may be contingent on the complexity of your debt structure as well as the market in which the attorney is operating.

How to file Chapter 13 bankruptcy

A Chapter 13 bankruptcy will last between three and five years, from start to finish. These processes are long and complex, so it’s strongly recommended that you use a lawyer. If you have a steady income, Chapter 13 bankruptcy allows you to keep property, like a house or car, that you might otherwise lose in Chapter 7. Chapter 13 develops a three-to-five year repayment plan for your debts.

The first step is to take a credit counseling course. Afterward, you or your attorney will prepare and file a bankruptcy petition and paperwork that includes a list of your creditors, a summary of your assets and liabilities and your Chapter 13 repayment plan; you will also need to provide your most recent tax returns.

The court will later appoint a trustee to administer your case and a stay on collections will take effect — this means that certain creditors won’t be able to proceed with lawsuits against you, call you for repayment or garnish your wages. You’ll begin making payments for a month after you file the paperwork. In addition, like Chapter 7, Chapter 13 also requires a 341 meeting.

You or your lawyer must attend a confirmation hearing where objections to your plan either by the trustee or the creditors will be addressed and eventually your plan for repayment will get confirmed.

Your creditors will also file proof of claim so that they can get repaid; it is at this point that you can object to the claim if you feel it is unfair.

The repayment period begins when you start to comply with your plan’s requirements and payments; this is the longest portion of the bankruptcy. If required by your plan, you may also have to submit documents to the court like income and expense statements.

Exactly as in Chapter 7, you’ll have another course to attend that goes over budgeting, using credit and managing money. Afterward, your debts may be discharged and your case closed.

Cost: There are two ways an attorney can charge you for handling your Chapter 13. It may be a “no look” fee, a flat fee set up by the district in your state, or they can bill you hourly. Your payment to your attorney can be worked into your Chapter 13 repayment plan.

Conclusion

Filing for bankruptcy is a big decision, and in the end you’re the only one who will know what’s right for you.

Bankruptcy can be not only a long process, but also a very emotional one for those seeking to discharge debts.

Do your research, evaluate all of your options, and then make the decision that most helps you reach your personal goals.

Looking into your options sooner rather than later may help you shore up your financial future and lose less in the long term.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Matt Becker is a writer at MagnifyMoney. You can email Matt here

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What To Do If You’re Being Sued For Debt

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If you’ve stopped making payments on a debt, and it’s been in collections for a while — and especially if you’ve been avoiding the debt collector’s attempts to contact you — it’s possible that you may get sued for that debt.

Not all unpaid debts will end in a lawsuit. Debt collectors are able to continue collection actions indefinitely, and only in certain cases will a lawsuit ever materialize.

“It’s always going to be a cost-benefit analysis by the creditor,” said Ed Boltz, a consumer debtor’s attorney in North Carolina. “The bigger the debt, the more likely it is that you’ll be sued. And when you owe money to an individual or small business, you are far more likely to be sued because they tend to take that debt personally.”

Being sued for debt can be a scary and intimidating process, but this article will help you understand how it works and what you can do to contest the charges.

What happens when you’re sued for debt

One of the keys to successfully challenging a lawsuit is simply understanding how the process works so that you know what to expect and how to respond.

The bad news is that you’ll have to do some leg work to get up to speed on the particulars for your state, as the specifics vary based on where you live.

“The details depend tremendously on what state you’re in,” said Boltz. “The process in North Carolina is different than the process in South Carolina, which is different than it is in California.”

The good news is that there are a few general steps that apply to most situations.

Timeline: When you’re sued for debt

What happens

What it means

Creditor files a complaint with the court

This officially begins the lawsuit. The complaint explains the charges against you.

You receive a summons and the complaint

The summons provides a deadline for your response.

You file an answer

This begins your defense and avoids a default judgment against you.

There is a trial or the case is dropped

The creditor can either drop the lawsuit or it will go to trial, typically in small claims court.

A judgment is made

The judge makes a decision, which will either relieve your responsibility or allow the creditor to begin collection actions.

Creditor files a complaint with the court

The lawsuit starts when the creditor files a complaint, typically in state court.

“Credit card debt, medical bills, those sorts of debt are sued in state courts,” said Boltz. “People are very rarely sued for debt in federal court.”

The complaint primarily explains who the creditor is suing, what debt they’re suing for, and how much they think you owe.

You receive a summons and the complaint

Once the complaint is filed, you’ll receive both the complaint and a summons that typically requires you to respond within 30 days. According to Boltz, these are usually mailed to you, though they can sometimes be delivered by a law enforcement officer or process server.

Boltz also warned that trying to avoid the delivery of these notices is a bad idea.

“A lot of people, if they’re sent the summons by certified mail, will attempt to ignore it and refuse to accept their mail,” said Boltz. “But all that ends up happening is that they have to get service to you through some other means, whether that means sending someone to your home or work or even putting it in the newspaper, all of which can be even more embarrassing.”

You file an answer

Once you receive the summons, Boltz said, you typically have 30 days to file an answer with the option to request an extension for another 30 days.

You will now have your chance to respond to the creditor’s claims and begin mounting a defense, and it’s at this point that Boltz recommends consulting with an attorney.

“The first thing you should do when you’re sued is go talk to a lawyer,” said Boltz. “That’s the best way to find out what your rights are and whether you have valid defenses against that lawsuit.”

It’s important to understand that even if you don’t have a good defense, it’s still important to file a timely answer. Refusing to answer will typically lead to a default judgment in favor of the creditor, at which point they may be able to garnish your wages, place a lien on your property or freeze your bank account in order to collect on the debt.

“The bottom line is that you can’t hide from the problem,” said Boltz. “The best thing to do is address it.”

There is a trial or the case is dropped

Once you file an answer, there’s a chance that the creditor may simply drop the lawsuit.

“It’s possible that the creditor will dismiss the lawsuit and decide not to proceed,” said Boltz. “They may do the cost-benefit analysis and decide that it’s not worth moving forward.”

Of course, they might not drop the lawsuit, and the case will go to trial. Boltz explained that most suits are handled in small claims court and follow a relatively standard procedure:

  1. The plaintiff (i.e. the creditor) presents their evidence.
  2. You are allowed to cross examine any witnesses they call.
  3. You present your evidence to either show that the debt is not yours, the amount is not correct, the statute of limitations has passed or any other defense.
  4. The plaintiff is allowed to cross examine your witnesses.
  5. Each side presents its closing argument.

A judgement is made

Once each side has made their closing argument, the judge — or, in rare cases, the jury — makes a decision and hands down a judgment.

If you win the judgment, by law you are no longer responsible for that debt. Unfortunately, that doesn’t mean that you’re 100% in the clear in terms of dealing with collection activities.

“The problem with debt collection is that often that debt will be sold to another debt collector who may or may not know that you’ve won that lawsuit,” said Boltz. “They may try to collect on it again, but at that point they’ve clearly violated the law, and you may be able to countersue and get some damages from them.”

If you lose the judgment, the creditor will have the right to begin collection actions against you. Depending on the state in which you live, that could include garnishing your wages, placing a lien on your home or other real property and even garnishing funds or freezing your bank account.

According to Boltz, judgments are good for 10 years and can be extended for another 10 years, and any unpaid amounts will sit there and accrue interest. So even if your home doesn’t currently have enough equity to cover your debt, the creditor can place a lien on your home, wait it out, and eventually either force you to sell once you do have enough equity, or demand repayment when you decide to sell it yourself or refinance your mortgage.

5 steps to take when you’re sued for debt

With that much on the line, what can you do to give yourself the best chance to win the lawsuit and avoid those collection actions?

Here are five steps you should take if you’re sued for debt.

1. Read the summons and complaint

First things first: Accept delivery of the summons and complaint and read them both thoroughly. Ignoring them will only lead to a default judgment against you, while reading and understanding them will help you meet deadlines and mount a convincing defense.

“When you get those papers, make sure you read them,” said Boltz. “Hiding from them doesn’t do you any good and is only likely to make you owe more money later on.”

Here are some important questions to ask as you read them over:

  • Who is suing you?
  • What is the debt they are suing you for?
  • How much are they claiming you owe?
  • Where has the suit been filed?
  • What is your deadline for filing an answer?
  • Where does that answer need to be filed?

2. Review your documentation

Once you know what your creditor’s suing you for, you can review your own documentation about that debt.

You may find that it’s not actually your debt, in which case you have a strong defense. And even if it is your debt, any information you have about when you took it out, payments you made and balances you owed will be helpful.

3. Consult an attorney

According to Boltz, hiring an attorney will give you the best chance to successfully challenge the lawsuit by making sure that you explore all possible angles.

“There are all kinds of valid defenses, from something as basic as ‘This isn’t my debt’ to something more complicated, like an application of the statute of limitations,” said Boltz. “A lawyer may also be able to find out that some of the ways in which the debt collection and the lawsuit were done were wrong, and you may have counterclaims against them.”

The Consumer Financial Protection Bureau suggests trying to find legal aid in your area, so be sure to look into opportunities to obtain free legal advice.

4. File an answer

No matter what, you want to file an answer by the deadline indicated on your summons. This allows you to avoid default judgment and gives you the chance to challenge the lawsuit in front of a judge.

5. Show up to court

Finally, if the lawsuit is brought to court, you need to show up and present your defense, no matter what. Again, showing up is the only chance you have to defend against the lawsuit and avoid a default judgment — so it’s an important step, even if you think your odds are low.

What to do if you’re held responsible for the debt

“If you get a judgment against you, you need to figure out how you’re going to pay it,” said Boltz. “Whether that’s by repaying it, negotiating a settlement, refinancing your home or filing bankruptcy.”

If you find yourself in this situation, check out some of MagnifyMoney’s free resources to help you evaluate your repayment options, including a guide to debt repayment, an overview of debt consolidation options and tips on how to negotiate a settlement on credit card debt.

In some cases, bankruptcy may even be the right move.

“If this is one part of a larger financial problem, bankruptcy may be the better financial option because it wipes the slate clean,” said Boltz.

And just as with the initial lawsuit, it’s important not to ignore the debt or simply refuse to repay it.

“If you don’t pay it, it will sit on your credit report for 10 years, and if they renew it, it counts as another lawsuit for another 10 years,” said Boltz. “You’re taking a beating on your credit report that in many ways is worse than a bankruptcy, because it shows that you have a judgment and you’re not dealing with it.”

Timely action is the key

Getting sued for debt can be nerve-rattling, but the good news is that you can often mount a valid defense as long as you understand the process and know how to respond.

Simply by filing timely and accurate responses, you greatly increase your chances of winning your case and avoiding repayment altogether.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Can Student Loans Be Discharged in Bankruptcy?

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Student loans are a large and growing problem.According to the Federal Reserve, student loan debt totaled over $1.5 trillion as of June 2018, up from $1.15 trillion just five years earlier. Over 44 million Americans have some level of student loan debt, and 11.2% of that debt is either in default or at least 90 days delinquent.

It’s no wonder that so many people are struggling to pay bills and save for the future under the weight of their student loans.

If you’re struggling with student loan debt yourself, you’ve undoubtedly wondered how you can get relief. And if you’re really desperate, you may have even considered bankruptcy.

Student loans are more difficult to discharge through bankruptcy than other types of debt, but it isn’t impossible. This article will explain how it works, the steps you need to take in order to discharge your student loans in bankruptcy and alternative strategies you should explore first.

Can you file bankruptcy on your student loans?

While it is possible to file bankruptcy on your student loans and have the debt discharged, it’s a difficult process with strict requirements that can be challenging to meet.

The baseline requirement is proving to the courts that repaying your student loans presents an “undue hardship,” a standard that is interpreted differently depending on where you live and which court happens to hear your case.

“It’s a mushy set of criteria that doesn’t lend itself to a lot of uniformity,” said Adam S. Minsky, an attorney who specializes in helping student loan borrowers. “The cases that I’ve seen come out with favorable decisions tend to be older borrowers, borrowers who have very long periods of unemployment or underemployment, and sometimes there are health issues, injuries, disabilities, things like that.”

Why your student loans are unlikely to be discharged

In the 1970s, a popular narrative began to emerge in the media about borrowers who were taking out student loans to attend college and then playing the system to get them discharged after they graduated.

There was no real data to support this claim, but in 1976, Congress acted on it anyway and passed a law that made it almost impossible to discharge federal student loans until either five years had passed since default or you were experiencing undue hardship. The waiting period was extended to seven years in 1990. In 1998, it was simplified to require undue hardship without a time element.

Then, in 2005, Congress updated the law once more to subject private student loans to the same undue hardship criteria as federal student loans.

At this point most courts, though not all, use something called the Brunner test to evaluate undue hardship.

What is the Brunner test?

The Brunner test looks at three factors to decide whether a particular borrower is facing an undue hardship.

First, you have to demonstrate that you are not able to maintain a minimum standard of living while repaying your student loans.

“This is typically the easiest one to prove,” said Jay Fleischman, a student loan lawyer. “You’re not required to be living like a pauper, but by the same token it’s presumed that you’re not going to be living a life of opulence.”

Fleischman said that while every judge interprets this standard differently, things such as paid sports for your kids, private school instead of public school and excessive cable packages may be deemed unnecessary.

Second, you must show that your situation is likely to persist for a significant portion of the repayment period through no fault of your own. That means that you can’t use your current income as an argument if there’s the opportunity to earn more elsewhere, and you can’t use extended unemployment if it either ended or is likely to end soon.

“It’s forward-looking criteria,” said Fleischman. “Courts will look at the marketability of your skills and the quality of the education you’ve received to determine your earning potential.”

Third, you must have made good faith efforts to repay your student loans prior to filing for bankruptcy.

“In some courts, for a federal student loan, that will mean that you’ve looked at one of the income-driven repayment (IDR) options,” said Fleischman. “For a private student loan, it might mean that you’ve attempted to rework your payments or tried for forbearance.”

Then there are some courts, specifically those in the 1st and 8th circuits, that don’t use the Brunner test at all.

“Some courts use what’s called ‘totality of the circumstances,’ which jettisons that three-part test in favor of looking at the totality of your situation,” said Fleischman. “It tends to be a slightly easier test but it’s not used very widely.”

At the end of the day, even when the Brunner test is used, the specific standards that need to be met to prove undue hardship are inconsistent and difficult to narrow down.

“What that test looks like and how it applies varies depending on where the borrower lives and what court they’re in,” said Minsky.

If you’re successful at proving undue hardship, the court can discharge your loans completely or grant a partial discharge. It can also simply change the terms of your loans to make them easier to pay, such as lowering the interest rate.

How to get your student loans discharged

If you believe that trying to get your student loans discharged through bankruptcy is the right move, here are the steps.

1. Hire a lawyer

While it is not absolutely necessary to hire a lawyer, Fleischman said that doing so is a good idea.

“If you’re going to file for bankruptcy to seek a discharge of those student loans, understand that it is very complicated and very skill-intensive,” said Fleischman. “An attorney will help you through that process.”

However, Fleischman also warned that you don’t get those attorney fees back if you are unsuccessful at getting your student loans discharged, which means that you need to be careful about taking on the extra expense when the odds of winning a judgment are low.

The National Consumer Law Center provides some resources to help you find an attorney.

2. File a bankruptcy case

If you do want to move forward, the next step is filing a bankruptcy case.

The Administrative Office of the U.S. Courts provides guidance on the paperwork needed to file, and it also advises that you check with your local court to see if there are other local forms you need to file.

3. File an adversary proceeding

Once your bankruptcy case is filed, you then need to file a separate lawsuit within the bankruptcy court against the lender of your student loan. This lawsuit is called an adversary proceeding and it asks the court to find that repaying your student loans would present an undue hardship.

“When you’re dealing with student loans you’re actually dealing with two separate cases, one living within the other case,” said Fleischman, explaining how the adversary proceeding acts as a separate case within the broader bankruptcy case.

You must file a complaint in order to initiate an adversary proceeding. This complaint identifies the court in which it’s being filed, the parties to the complaint, a summary of the situation and reason for the complaint, and the specific relief you are seeking from the court.

The National Consumer Law Center provides a sample of what this complaint could look like.

4. Go through discovery

Discovery is the process of gathering evidence and exchanging information between parties to the lawsuit. It can be complicated, and it is one area where having an attorney can be a big benefit.

“Once you’ve filed the case with a summons and complaint, the lender has the opportunity to answer and to conduct discovery, as do you,” said Fleishman. “This could involve the exchange of documentary information, depositions, expert testimony and the like.”

It’s also worth noting that this process can be time-consuming and expensive. The National Consumer Law Center estimates that the entire litigation process can require a total of 40 to 100 hours, and according to Fleischman, you can expect to pay anywhere from $4,000 to $15,000, on top of attorney fees.

5. Proceed to trial and judgment

After discovery, the case goes to trial, evidence is presented from both sides, and the judge eventually makes a decision.

If you are not awarded a discharge, Fleischman said that you are allowed to appeal. But doing so is both rare and likely unsuccessful.

5 alternative ways to deal with your student loan debt

While bankruptcy can be an effective tool, and in some cases the best way to get out from under the weight of your student loans, it generally shouldn’t be your first option.

Here are five alternative approaches to consider before filing for bankruptcy.

1. Revisit your budget and spending habits

Given that you’ll have to prove to the court that your income isn’t enough to meet your expenses, it makes sense first to take a close look at your budget and figure out if there are any changes you can make that would help you afford your student loan payments.

“I always tell my clients to first look at their spending and determine where their money leaks are and try to plug those leaks,” said Fleischman. “Determine where your expenses can be reduced and start there.”

2. Consider IDR

If you have federal student loans, you may be eligible for IDR, in which your monthly payment is adjusted according to your income and family size. The less you make and the bigger your family is, the less you’ll have to pay.

There are downsides to IDR, such as the fact that you may end up paying more interest over time and that it may take longer to get out of debt. But if you’re truly unable to afford your monthly payment, those downsides may be worth the immediate relief.

3. Work toward loan forgiveness

One of the additional benefits of IDR plans is that they can eventually lead to loan forgiveness.

If you work for the government or a qualifying nonprofit, you may be eligible for Public Service Loan Forgiveness, which forgives your student loan debt tax-free after 10 years of eligible payments.

Otherwise, you may be eligible for forgiveness after 20 to 25 years, depending on the type of IDR plan in which you enroll. The amount forgiven would be taxable, but it could still provide significant relief.

4. Consider refinancing private student loans

Refinancing your private student loans could allow you to secure a lower interest rate and extend your repayment period, either of which could lower your monthly payment.

“You need to be careful about it because you want to make sure that you’re actually saving money instead of spending more,” said Fleischman. “But this may be a situation in which refinancing makes sense.”

Fleischman did warn against refinancing federal student loans, primarily because of the protections offered by the federal government. These protections are lost in refinancing.

5. Strategic default and settlement

In some cases, Fleischman argued, it might be a good idea to strategically default on private student loans in order to create a settlement opportunity.

“Settlement of any debt is seldom an option when you are paying the debt according to the terms and conditions of the loan,” said Fleischman. “It’s just not the way that business is transacted. In those situations, a strategic default may make some sense.”

Fleischman warned that there are negative consequences to default, such as the impact on your credit score, the collection actions that would be taken against you and the fact that there is no guarantee that you will be able to settle at all, nevermind along favorable terms.

But if you’re hoping for a settlement instead of entering bankruptcy, defaulting may be the best way to create that opportunity.

Proceed with caution

At the end of the day, the reality is that discharging your student loans through bankruptcy is a difficult and unlikely proposition.

That doesn’t mean that it should always be avoided, as there are situations in which it’s the right move. You just need to go into the process with your eyes wide open.

“Make sure that you investigate all of your other options first,” said Fleischman. “And if you are going into bankruptcy, make sure you understand completely what you’re getting into and that you have a realistic sense of what your opportunity for success is going to be.”

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3 Times a 401(k) Loan Can Be a Good Idea

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Updated: Oct 24, 2018

If you hear the words “401(k) loan” and immediately think to yourself “ooh, that sounds like a bad idea”, good for you! You’re on the right track.

In most cases borrowing from your savings isn’t a smart move, particularly when it’s from an investment account like your 401(k) that’s meant to sit untouched for decades so that it can grow and eventually allow you to retire.

But a 401(k) loan is unique. We covered the ins and outs of how it works in a previous post, but here are the basics:

  • The loan comes directly out of your 401(k) investments.
  • Repayment is made through automatic payroll deductions.
  • Both the principal and interest are paid back into your 401(k), so you truly are borrowing money from yourself.
  • The loan is typically easy and quick to get.

The fact that you pay the interest back to yourself is especially unique and makes 401(k) loans attractive in certain situations.

So while you should proceed with extreme caution when considering a 401(k) loan, and while in most cases there are better options available to you, here are three situations in which a 401(k) loan can be a good idea.

1. Increase your investment return

There are certain situations where you can use a 401(k) loan to increase your overall investment return. Here’s a hypothetical example showing how it can work.

Let’s say that the following things are true:

  • Your 401(k) money is invested partially in a stock mutual fund and partially in a bond mutual fund.
  • The bond mutual fund currently has an SEC Yield of 1.97%, meaning you can expect about a 1.97% return from that fund going forward (though there are no guarantees).
  • You can borrow money from your 401(k) at 4.5%.

Given that scenario, here are the steps you could take to increase your expected investment return while only adding a small amount of risk:

  1. Take out a 401(k) loan, borrowing money from the bond portion of your account.
  2. Put the loan proceeds into a taxable investment account and invest it in the exact same bond fund (or something similar).
  3. You will earn the exact same return on the bond fund as you would have in the 401(k), less the cost of taxes you have to pay on any gains.
  4. As you pay back your 401(k) loan, the 4.5% interest is essentially a 4.5% return since it’s going right back into your 401(k).

In other words, you’re getting essentially the same return on your bond fund in the taxable account, minus the tax cost. But you get a higher return in your 401(k) because the interest rate is higher than the expected return on the bond fund.

And since your bond investment is unlikely to fluctuate too much (though it can certainly fluctuate some), in a worst-case scenario where you lose your job and have to pay the loan back in full within 60 days, you will likely to have the money available to do so.

Here are a few things to keep in mind as you consider this approach:

  • The more expensive your 401(k) is, the more likely this is to work out in your favor. That’s because you can choose a lower cost bond fund in your taxable account and save yourself some fees over the life of the loan.
  • The higher your tax bracket, the less advantageous this is since the tax cost in the taxable investment account will be higher.
  • Make sure you’re not sacrificing your ability to contribute to your 401(k), and definitely make sure you’re not missing out on an employer match.

2. Paying off high-interest debt

If you have high-interest debt, taking a 401(k) loan to pay it off could be a good idea.

Before you do so, make sure you’ve exhausted all other options. Do you have savings you could use to pay it off? Are there any expenses you could cut back on so you could put that money towards your debt? Are there any creative ways you could make a little extra money on the side?

Any of those options are better than a 401(k) loan simply because they don’t require you to borrow against your retirement and they don’t come with the risks that a 401(k) loan presents.

But if you’ve exhausted those other options, paying off high-interest debt with a 401(k) loan has two big benefits:

  1. Your 401(k) loan interest rate is likely lower than the rate on your other debt.
  2. You pay the 401(k) loan interest to yourself, not someone else.

The big risk you run with this strategy is the possibility of losing your job and having to pay the entire 401(k) loan balance back within 60 days. If that happens and you’re not able to pay it back, the remaining balance will be taxed and subject to a 10% penalty. That outcome is likely much more costly than your high-interest debt.

3. Financial emergency

If you’re in a situation where you absolutely need money for something and you don’t have the savings to handle it, a 401(k) loan may be your best option.

Here’s why:

  • It’s quick. You can often get the loan with just a few clicks online.
  • There’s no credit check. You’ll be able to get it even if you don’t have a great credit history.
  • It likely has a relatively low interest rate and you pay the interest back to yourself.

In an ideal world this is exactly what your emergency fund would be there for. But of course life happens and a 401(k) loan can be a good backup plan.

Why you may want to consider a personal loan instead

To be sure, borrowing from your 401(k) comes with some significant downsides, even in the situations above.

First and foremost is the fact that your 401(k) is meant to be a retirement savings account, and borrowing from it in the short term at least temporarily sacrifices the growth of that money. Then there’s the fact that if you leave your company, you’ll typically have to pay back the loan within 90 days or else the remaining balance is considered a withdrawal subject to taxes and penalties.

On top of all that, your employer may not allow you to make 401(k) contributions as long as you have an outstanding loan balance, which further sacrifices your ability to save for retirement.

With those downsides, it often makes sense to consider taking out a personal loan before resorting to a 401(k) loan. You can borrow the money you need without sacrificing your retirement savings and you aren’t running the risk of having to immediately pay back the entire balance if you lose your job.

The biggest disadvantages of a personal loan compared with a 401(k) are the stricter credit requirements and the potential for a higher interest rate. There may also be an origination fee that increases the cost of the loan.

But at the end of the day, a personal loan is often the safer option because it avoids the biggest risks that come with a 401(k) loan.

Pros of a personal loan

  • They are unsecured debt, which means that the bank can’t come after your investment accounts, your home or any other asset if you aren’t able to make payments.
  • You aren’t sacrificing your retirement savings.
  • You won’t have to pay back the entire balance if you lose your job
  • Most personal loans have fixed interest rates with fixed monthly payments, which makes budgeting easier.

Cons of a personal loan

  • Depending on your credit score, income, debt-to-income ratio and other factors, a personal loan may come with a higher interest rate than a 401(k) loan. Interest rates on personal loans currently range from 3.34% all the way up to 35.99%.
  • Some personal loans will have an origination fee.
  • Unlike a 401(k) loan, you aren’t paying interest back to yourself.
  • At the end of the day, a personal loan is still debt that needs to be repaid and is costing you in the meantime.

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Should you go with a 401(k) loan?

401(k) loans come with significant risk and should almost never be your first choice. The hit to your retirement savings is real, as is the risk of a job loss that would force you to either repay the loan or deal with the penalties, so it should typically only be considered after all other options have been exhausted.

But in the right situations a 401(k) loan be helpful, and may even lead to better returns. As long as you proceed with caution and make sure you understand exactly what you’re getting into, a 401(k) loan can be a valuable tool in your financial arsenal.

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How to Get Your Hospital Bill Reduced or Even Eliminated

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Here’s a little secret that many hospitals don’t want you to know: the bill they send you is only an initial offer.

There is almost always room to negotiate, and in some cases you can get your bill reduced by as much as 90% — or forgiven entirely.

All it takes is knowing who to ask.

Hospital financial assistance

You may not have known that many hospitals — nonprofits in particular — have financial assistance programs designed to help people pay for medical care they couldn’t normally afford.

And there are two situations where you’re especially likely to qualify.

1. You’re uninsured

The first situation is if you’re uninsured. Often, simply being uninsured can result in an automatic bill reduction, no matter your income. Those with lower incomes may qualify for even bigger reductions.

Keep in mind that this isn’t necessarily a reason to go without insurance. Insurance comes with many protections, such as a maximum out-of-pocket cost and pre-negotiated rates for procedures that reduce the cost without any work on your end. Not to mention you avoid penalties for being uninsured.

2. You owe a significant amount after insurance

The second situation is if you are insured but your insurance only covers part of the cost. The lower your income and the more of your bill for which you’re responsible, the more likely it is that you’ll qualify for help.

3 forms of financial assistance

If you find yourself in one of the above situations, there are three forms of financial assistance for which you may be eligible.

1. Bill reduction or forgiveness

The first is a bill reduction or potentially total forgiveness. This Redditor got a $12,000 bill reduced to $1,500 by contacting the hospital’s billing department — and there are other stories in the thread from people with similar experiences. In general, the more difficult your circumstances, the more that part of your bill may be forgiven.

2. 0% interest repayment plan

The other type of help that most hospitals offer is a payment plan with 0% interest. These programs are often offered without any eligibility requirements, meaning anyone can enroll. And while they don’t reduce your bill, they can make it easier for you to afford the expense by spreading out the cost over a period.

In some cases, you may qualify for a bill reduction and a 0% interest payment plan.

If your hospital does not offer a payment plan but does accept credit cards, you can consider applying for a card with a 0% intro APR on purchases.

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3. Personal loans for medical debt

If you have medical debt that cannot be resolved with the hospital, you may consider taking out a personal loan to cover your medical bills. A personal loan could give you a year or longer to pay off your medical debt.

If you are already making payments on several medical bills, you could use a personal loan to consolidate them. That would allow you to make one payment per month on your debt instead of multiple payments. Doing so could also reduce the interest you pay on your debt.

While personal loan lenders generally don’t have specific refinancing programs for medical debt, they’ll likely let you use the loan funds to do so.

If you have a stable work and education history and a good FICO score, a personal loan may be the right fit for you.

To compare lenders and receive offers, you can explore MagnifyMoney’s personal loan marketplace. You can filter lenders by your credit score, loan amount and ZIP code. Many of the lenders you’ll find in this marketplace have no origination fees, prepayment penalties or other hidden fees. And some lenders, such as LightStream, offer fast application processing, meaning that same-day funding could be available. Use our table below to compare up to 5 lenders! Clicking “see offers” does not affect your credit!

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If you have poor or no credit, you may only qualify for high rates on personal loans. In that case, you may need to reconsider your options. Weigh the cost of a personal loan before committing. You don’t want to replace your medical bills with debt that is difficult to repay.

How to get financial assistance from the hospital

To see whether you qualify for financial assistance, the best thing to do is reach out to your hospital as quickly as possible once you have your bill in hand.

“Just ask,” said Pam Horack, CFP® and founder of Pathfinder Planning. “I have found that if you contact the hospital billing department about payment, they are more than willing to work with you.”

Thomas Nitzsche of Clearpoint Credit Counseling Solutions agreed. “Act immediately upon receiving the bill and contact the billing department of the provider and ask to apply for financial aid, even if you think you make too much,” he said.

Figuring out who to ask

To figure out who to contact, look at your bill. There should be a phone number for the billing department on it, and you can call and ask about financial help. If that doesn’t work, Google “your hospital” + “financial assistance.” That should bring you directly to its financial assistance program with contact information to get you started.

From there, follow the instructions and provide the information needed. Though Melanie Lockert, the founder of Dear Debt who three years ago had a $1,600 bill forgiven, acknowledges that the process can take some time.

“I was grateful that they covered everything, but I did have to hand over a lot of information: bank statements, tax info, pay stubs and any other documentation to help my case,” Lockert said. “It took about two months for me to get the letter saying that everything was covered.”
If you run into any issues or are having trouble understanding your bills or organizing your financial situation, you might consider reaching out to a nonprofit credit counseling service for help. The National Foundation for Credit Counseling is a good place to start.

How to negotiate your medical bills

What if you don’t qualify for a bill reduction, or the bill isn’t reduced by as much as you’d like? What are your options?

Pay in cash (or with a flexible spending account)

You may be able to negotiate a lower bill, especially if you can pay upfront with cash.

“Sometimes doctor offices, hospitals, labs and other medical facilities will offer a discount if you pay your portion of the bill in full,” said Shanda Sullivan, CFP® and founder of Sullivan Financial Strategies. “I myself and a client have saved 5% to 10% off of our medical bills. It never hurts to ask.”

Horack added: “When I have had large bills, I called and asked if I could get a discount for paying cash. They reduced my bill by 20% and I paid with my FSA (flexible spending account).”

Research pricing at other hospitals

Another strategy is to research the average cost of the care you received using sites such as Healthcare Bluebook — or even call other local hospitals. If your hospital is charging you more, you could use that information as leverage for getting your bill reduced.

The bottom line is this: You have options when it comes to reducing your hospital bill. Often, the simple act of asking can save you a lot of money.

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How a Student Loan Interest Deduction Works

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When you have student loan payments on top of all your other bills and financial responsibilities, every little bit of savings helps.

The student loan interest deduction won’t make you rich, and it won’t completely relieve the burden of your payments. But it could save you a few hundred dollars per year, so it’s worth understanding how it works and how you can take advantage of it.

What is the student loan interest deduction?

The student loan interest deduction allows you to subtract some of the interest you paid on your student loans during the year from your taxable income. By reducing your taxable income, the deduction saves you money by diminishing the amount of taxes you owe.

The IRS allows you to deduct up to $2,500 of interest paid per year on “qualified student loans,” which is any loan that was:

  • Taken out for you, your spouse or a qualifying dependent
  • Used to pay qualified higher education expenses for an eligible student
  • Used within a reasonable time period after taking out the loan

According to Jason Speciner, CFP, enrolled agent and the founder of Financial Planning Fort Collins, the definition of “qualified student loan” is broader than you might think.

“Interest on loans that are specifically student loans obviously counts, but you’re allowed to take the student loan interest deduction for any debt as long as it meets certain standards,” said Speciner. “It has to be used only for education expenses [and] it has to be debt that isn’t otherwise deductible.”

As an example, Speciner says that a personal loan taken out within 90 days of receiving your tuition bill would count, as long as the loan is only used for education expenses. A home equity loan, however, typically wouldn’t be eligible since it is not strictly related to your education expenses.

Wendy Marsden, CPA, CFP and principal at ProsperiTea Planning, adds that private student loans are also eligible for the deduction and that you might be able to deduct the interest from your state tax as well.

“Many states have what are called ‘piggyback taxes’ that say that whatever your federal income is, that’s what they’ll use as your state income tax base,” said Marsden. “In that case, if it’s deductible at the federal level, then it’s deductible at the state level too.”

Marsden emphasized that it is only the interest portion of your student loan payment that’s deductible. Some of each payment goes toward the principal of your loan, and that portion isn’t deductible.

However, one of the big advantages of the student loan interest deduction, according to Speciner, is that it’s an above-the-line deduction, meaning that you don’t have to itemize deductions in order to claim it.

“That’s the beauty of this thing,” said Speciner. “If you look at the typical taxpayer who’s within the income range that’s allowed to claim the deduction, they’re typically not itemizing deductions. But here, they’re still allowed to take it.”

The bottom line is that if you’re repaying any debt taken out exclusively for education expenses, the student loan interest deduction can help ease the burden of those payments by reducing your tax bill.

Do you qualify for the student loan interest deduction?

The downside of the student loan interest deduction is that not everyone will qualify. There are several criteria you have to meet.

First, as explained above, the interest has to be paid on a “qualified student loan,” taken out for you, your spouse or a qualifying dependent.

Second, you must have personally paid the interest during the tax year in question, and you must be legally obligated to pay that interest. One of the implications here is that if you are a parent making payments on your child’s student loan and you aren’t a cosigner on it, you are not allowed to deduct those interest payments because you are not personally obligated to make them.

“For a personal example, I told my son that I would pay his student loans if he got [a grade point average of] over a 3.0,” said Marsden. “He did that, so now those loans are in his name, but I am paying them, and I can’t take the deduction even though I’m paying the interest.”

You also can’t claim the deduction if you are married but file taxes separately. You must either be a single filer or file jointly as a married couple, and you must not be claimed as a dependent on anyone else’s tax return.

Finally, the deduction is phased out once your income reaches a certain point. For single filers, the phaseout begins when your Modified Adjusted Gross Income (MAGI) reaches $65,000, and the deduction is eliminated completely once your MAGI reaches $80,000. For married couples filing jointly, the phaseout runs from $135,000 to $165,000.

“It’s almost always income that keeps people from being able to claim the deduction,” said Speciner. “I have clients come in with $5,000 of interest paid during the year, and I have to tell them they can’t deduct it because their income is too high.”

On the other hand, Marsden points out that there are a few sweet spots where the deduction can be incredibly valuable.

“Teachers are a really good example of people who can benefit from the student loan interest deduction,” she said. “Anybody with a medium- to low-earning career, or anyone who is early in their career, can benefit from it.”

How to calculate your student loan interest deduction

In a moment, you’ll learn how to report the exact right amount of student loan interest you paid for tax purposes, but first you might want to know ahead of time how much you stand to save.

Here’s a process that will help you estimate the value of your student loan interest deduction:

    • First, make sure you’re not above the income limits. For single filers, that’s a MAGI of $80,000, and for joint filers, it’s a MAGI of $165,000. Click here for an overview of how to estimate your MAGI. If you are over those limits, you won’t be able to claim the deduction.
    • For each individual student loan, multiply your current balance by your interest rate to get the approximate amount of interest you’ll pay during the year. For example, if you have a $10,000 loan with a 6.8% interest rate, you can multiply them together to get an estimated annual interest payment of $680.
    • Add together the estimated interest for each loan to get the total amount of interest you expect to pay across all your student loans.
    • Cap that number at $2,500.

 

  • If you’re single and your MAGI is between $65,000 and $80,000, or if you’re married and your MAGI is between $135,000 and $165,000, you’ll have to calculate your phaseout. To do that, first subtract the bottom MAGI limit ($65,000 for singles, $135,000 for couples) from your estimated MAGI, then divide that result by either $15,000 if you’re single or $30,000 if you’re married filing jointly. Here’s an example:
    • You’re married, filing jointly and your estimated MAGI is $150,000.
    • Subtract $135,000 (the bottom MAGI limit) from $150,000 to get $15,000.
    • Divide $15,000 by $30,000 (single filers would divide by $15,000).
    • That result is 0.5.
    • Multiply 0.5 by the total interest you calculated in Steps 3 and 4 to determine the final amount you’ll be able to deduct.
  • Multiply the amount of interest you’re able to deduct by your federal tax rate to get your estimated savings. For example, if you are in the 22% tax bracket and you can deduct $2,500 in student loan interest, you stand to save $550 at tax time. If you’re not sure what your tax rate is, you can use this tool from TurboTax.
  • If the interest is deductible for state income tax purposes as well, you can multiply your state tax rate by the amount of your eligible interest to calculate your additional savings.

However, there are a few other factors to consider.

According to the IRS, the interest is only deductible to the extent that the loan was used to pay qualified education expenses, and those expenses are reduced by other money that was received tax-free for that same purpose, including:

  • Employer-provided education assistance
  • Tax-free distributions from a 529 plan or Coverdell ESA
  • Savings bond interest used for education
  • Scholarships and grants
  • Veterans’ educational assistance
  • Other tax-free payments used for education, aside from gifts or inheritances

In other words, if you used any of those sources to pay for education expenses, and you think that as a result, your entire student loan balance may not have gone toward qualified education expenses, you may want to consult with a CPA before deducting all of your student loan interest.

On the other hand, the IRS does allow you to count a few additional expenses as interest for the purpose of the student loan interest deduction:

  • Loan origination fees
  • Capitalized interest, which is interest that has been added to the principal of the loan
  • Interest on credit card debt, as long as that debt was used solely to pay for qualified education expenses
  • Interest on refinanced and consolidated student loans

Steps to claiming your student loan interest deduction

For the most part, claiming your student loan interest deduction is fairly simple. The biggest potential hang-up is simply figuring out exactly how much interest you paid.

In general, any lender that received $600 or more in interest payments from you during the year must send you a Form 1098-E, which will specify exactly how much interest you paid. However, that form might not include things like loan origination fees or capitalized interest, which would also be eligible for the deduction.

You may not always receive a Form 1098-E, either because you didn’t pay at least $600 in interest or because your lender didn’t mail it out, in which case you may need to do some digging.

“The lender is going to have a statement or a website where you can see how much interest you paid during the year, as well as other relevant information,” said Speciner. “And if you used another type of debt, like a personal loan, you won’t get a Form 1098-E, and you’ll definitely have to use the lender’s records at that point.”

Once you have that information, Speciner says it’s simply a matter of providing it to your tax professional or entering it into the tax preparation software you’re using. Your allowed deduction will be calculated and added to your return.

If you’d like to fill out your tax return on your own without the help of a professional or software, IRS Publication 970 has detailed guidance on both calculating and reporting your deduction.

Taking full advantage of the student loan interest deduction

The student loan interest deduction doesn’t completely relieve the burden of making payments, and it doesn’t eliminate the cost of your loans. But it’s a helpful way to save a little bit of money if you’re able to claim it, and as Marsden points out, the best way to take advantage is to simply be aware that it exists.

“The hardest part is not knowing that it’s there,” she said. “So just knowing that there’s a deduction, you can find the other information you need to find.”

In most cases, all you need to do at tax time is get an accurate record of the amount of student loan interest you paid during the year on each eligible loan and make sure you report it either to your professional tax preparer or into your tax-prep software. Doing so will allow you to take full advantage of the student loan interest deduction.

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Matt Becker is a writer at MagnifyMoney. You can email Matt here

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College Students and Recent Grads

How to Understand Your Student Loan Amortization Schedule

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

obama student loan forgiveness
Source: iStock

Paying off your student loans is no easy feat. It can be hard enough to fit the minimum monthly payments into your budget. And if you want to pay them off earlier, you’re left to navigate the various types of loans and interest rates in order to determine your best options.

One helpful step in cutting through the confusion, getting organized and creating a repayment plan is understanding your various student loan “amortization tables.”

An amortization table breaks down every single one of your student loan payments over the life of your loan, showing how each payment is split between principal and interest. It also shows you how much interest you’ll pay over the life of the loan and how quickly your loan will be paid off.

It’s vital information if you want to pay off your student loans as quickly as possible. Read on to find out how amortization tables can help you do just that.

Understanding a student loan amortization schedule

Amortization is simply the process by which your loan payments are split between interest and principal. That split determines how quickly your loan is paid off and how much interest you pay over that period.

“When you take out a student loan, you’re borrowing a certain amount of money that needs to be paid back,” said Lauryn Williams, CFP and founder of Worth Winning. “And the lender also needs to get some kind of return, which is where interest comes into play. So your payments have to balance paying back the loan and paying interest, so that by the end of the loan term the entire debt is paid.”

The catch is that each payment differs in how it’s split between principal and interest. This happens for two main reasons:

  1. Each payment is first used to pay off any interest that has accrued since the last payment, with the remainder used to reduce the loan principal.
  2. The accrued interest is typically highest at the beginning of the loan repayment period, when the loan balance is also at its highest.

What that means is that a significant portion of your initial payments will go toward interest. But over time, as you continue making payments that decrease the loan balance, less interest accrues between payments, and so more of each payment can go toward paying down the principal.

An amortization table is simply a graphic that shows you exactly how each payment will be split between principal and interest over the life of the loan.

Here’s an example that shows the first six payments and last six payments of a $10,000 student loan with a 6.8% interest rate during a 10-year repayment period:

Sample Student Loan Amortization Table

Based on someone with a $10,000 student loan at a 6.8% interest rate over a 10-year (120-month) repayment period.

Month

Your monthly payment

Portion of the payment that goes toward principal

Portion of the payment that goes toward interest

Total interest paid so far

Remaining loan balance

1

$115.08

$58.41

$56.67

$56.67

$9,941.59

2

$115.08

$58.74

$56.34

$113.00

$9,882.84

3

$115.08

$59.08

$56.00

$169.01

$9,823.76

4

$115.08

$59.41

$55.67

$224.67

$9,764.35

5

$115.08

$59.75

$55.33

$280.00

$9,704.60

6

$115.08

$60.09

$54.99

$335.00

$9,644.52

...

115

$115.08

$111.24

$3.84

$3,799.99

$565.75

116

$115.08

$111.87

$3.21

$3,803.19

$453.87

117

$115.08

$112.51

$2.57

$3,805.76

$341.36

118

$115.08

$113.15

$1.93

$3,807.70

$228.22

119

$115.08

$113.79

$1.29

$3,808.99

$114.43

120

$115.08

$114.43

$0.65

$3,809.64

$0.00

As you can see, the initial payments are split roughly 50-50 between principal and interest. But by the time those last few payments are made, the amount going toward principal has increased to almost 100% of the monthly payment.

A full amortization table would show exactly how much is going toward principal and interest for each of the 120 payments, as well as what your remaining loan balance is along the way. This helps you understand exactly how your student loan will be paid off over time.

A student loan amortization table also helps you understand the total amount of money you’ll be spending over the life of the loan. In the example above, you can see that you would pay a total $3,809.64 in interest over 10 years, in addition to the $10,000 needed to pay back the principal.

“You really need to think about the long-term cost of the money you’re borrowing,” said Williams. “An amortization table makes it easy to see the true cost of the loan in a way that you can understand.”

That cost can be incredibly high, especially if you’re borrowing large amounts of money and paying it off over extended 20- to 25-year time periods. Clint Gossage, CFP and founder of CMG Financial Consulting, sees this often with professionals who have borrowed hundreds of thousands of dollars.

“In some cases, the total amount of student loan payments may be several times your current balance by the time it’s all paid off in the end,” said Gossage. “It’s important to understand how long it’s really going to take to pay back your loans and how much it’s going to cost.”

Amortization and income-driven repayment plans

If you’re enrolled in an income-driven repayment plan, your payment is based on your monthly income, and it may fluctuate over time.

This can lead to unpredictable amortization, and in some cases your monthly payment might not be enough to cover all of the interest that accrues. That’s called negative amortization, and how it’s handled depends on the type of loan and the repayment program you’re participating in.

  • For subsidized loans under REPAYE, the government will pay all remaining interest for up to three consecutive years from the start of your REPAYE plan. After that, the government will pay half of the remaining interest on subsidized loans.
  • For unsubsidized loans under REPAYE, the government will pay half of remaining interest during the entire life of the loan.
  • For subsidized loans under PAYE or Income-Based Repayment (IBR), the government will pay all remaining interest for up to three consecutive years at the beginning of your repayment plan. After that, unpaid interest will accrue without any government assistance.
  • For unsubsidized loans under PAYE or IBR, unpaid interest will accrue from the beginning without any government assistance.

Steps to beating the student loan amortization schedule

If you’re looking at your student loan amortization table thinking that it will either take too long or cost too much to pay off your student loans, there are a few strategies that could accelerate your repayment. Doing so can not only save you money, but it can free up money for other goals.

“The biggest benefit of paying off your student loans early is that it frees up cash flow to do the things that you want to do with it, whether those are lifestyle choices or investing for your future,” said Gossage. “Not to mention the big relief that comes from having the weight of those loans off your shoulders.”

Here are some strategies that could help you beat your student loan amortization table and pay your loans off faster.

1. Cut back on other expenses

One of the best ways to find more room for student loan payments is to simply look at your other expenses and find places to scale back.

“I find that your car and housing are two big expenses that people are able to cut back on,” said Williams. “If you can get a roommate or trade in your $700 per month car payment for a $3,000 jalopy, it can make it a lot easier to pay off your loan.”

Williams said that while these changes might be difficult to make, the long-term benefit can be huge.

“You have more time than you might think for other goals if you really focus on this for a short time period,” Williams said. “If you do what you need to do to get those student loans off your back, you can free yourself up to really do the things you want to do.”

2. Automate extra payments

If you have the room in your budget to make regular extra payments toward your student loans, automating those payments helps to make sure they happen consistently.

“One of the best things you can do is make sure that every time you get paid, the first thing you do is send a payment to your student loan,” said Williams. “If you can do that with just a few clicks, then why not?”

Automating your payments allows you to make consistent progress and it frees you from the burden and stress of having to remember to manually make those payments each month. And if you have private student loans, lenders will often give you a discount on your interest rate if you sign up for autopay.

3. Refinance (with caution)

If your student loans have higher interest rates, refinancing could be a good option to explore.

“Interest rates are very high if you have federal loans, typically between 6% and 8%,” said Gossage. “If you use one of the private lenders out there, you could get a much more competitive rate.”

You need to be cautious, however, especially before deciding to refinance federal loans. Federal student loans include a number of protections that aren’t typically offered by private student loans, such as the ability to enroll in income-driven repayment programs, have some of your debt forgiven and temporarily postpone payments if you run into financial difficulty.

“Once you’ve moved your loans from federal to private, that’s a forever move, and you need to be really committed to paying your loans off,” said Williams. “If you owe more than 1.5 times your annual salary in student loans, then refinancing from federal to private might not be a good idea.”

However, the decision to refinance is a lot easier if you’re starting with private loans.

“If you already have private loans in place and you’re thinking about refinancing, you should usually go for it if you can get a better interest rate,” said Williams.

Check out our top picks for refinancing your student loans.

4. Prioritize higher interest-rate loans

There are two schools of thought when it comes to paying off debt.

The debt snowball approach argues for paying the lowest balance loans first, since doing so will provide the motivation you need to keep going. The debt avalanche approach argues for paying the highest interest-rate loans first, since doing so will save you the most money and pay off your loans more quickly.

“It really depends on how you’re mentally ready to deal with your loans,” said Williams. “A lot of people enjoy paying the smallest loan off first so that you can feel like you got a big win. But if you have the ability, it’s usually best to go after the highest interest rate first.”

You can use this tool to run the numbers yourself, but directing extra payments to your student loan with the highest interest rate is generally the most efficient route.

5. Take advantage of income-driven repayment

You may be eligible for income-driven repayment if you have federal student loans. These programs adjust your monthly payment based on your income. They also offer the opportunity to have some of your loan balance forgiven down the line, and they can make it easier to prioritize your payments toward your most expensive loans.

“Staying on an income-driven plan like REPAYE can give you a low monthly payment, and then any free cash flow you have can go toward the highest interest rate first,” said Gossage. “That’s a good way to make progress if you only have a little bit of extra cash flow to put toward your student loans.”

Gossage also stressed the potential benefits of student loan forgiveness under these plans, especially if you qualify for Public Service Loan Forgiveness.

“It still takes 10 years to get your loans forgiven, but in that time you can be in an income-driven plan that minimizes your payments and frees up cash flow to do other things,” said Gossage. “Instead of putting all your money toward student loans, you could be saving for retirement, saving for a down payment on a house or making progress toward one of your other long-term goals.”

Making student loan amortization work for you

Student loan amortization isn’t the most exciting topic in the world, but it is key to understanding the long-term cost of your student loans, as well as how to pay them off as quickly and efficiently as possible.

With the right payments to the right loans at the right times, you can save money and get to being debt-free a whole lot sooner.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

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Best of, College Students and Recent Grads, Life Events

How to Find the Right 529 Savings Plan for You

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

It is never too early to think about saving for college, and a 529 savings plan can help you do just that.

No other savings or investment account offers the tax breaks that a 529 college savings plan offers, which means that every dollar you contribute can cover a greater share of college costs. That’s especially helpful considering the average net price of a private nonprofit university came in at $26,740 for the 2017-18 school year, and the cost of college is on the rise.

But with almost every state offering a 529 savings plan, and with many offering more than one, it can be challenging to figure out which plan is right for you.

If you’re already well-versed in this savings tool, you can see our roundup of the best options here:

The truth is that contributing to a 529 savings plan isn’t always the right move. You may be better off using a different college savings account or even focusing on other financial responsibilities first.

This guide will help you sort through all of that. You’ll learn what a 529 college savings plan is, how it works, how to choose the right plan for you and alternatives you should consider.

What is a 529 college savings plan and how does it work?

A 529 college savings plan is an investment account that offers a number of tax breaks when the money is used for qualified education expenses:

  • Contributions are made after taxes, though there are a number of states that allow either a deduction or a credit for state income tax purposes.
  • Your money grows tax-free while it is in the account.
  • Money can be withdrawn tax-free for qualified education expenses, which typically includes tuition at any eligible school from elementary onward, as well as fees, books and room and board at an eligible higher education institution. If you withdraw the money for any other type of expense, the earnings will be taxed and subject to a 10% penalty.

529 savings plans offer a preselected set of mutual funds and your account balance will rise and fall based on your contributions and the performance of your chosen investments. Most 529 savings plans also offer age-based investments that provide an all-in-one portfolio and automatically become more conservative as your child approaches college.

529 savings plans are administered by states, with every state except for Wyoming offering at least one plan. However, you do not have to use your home state’s plan, and in some cases, you may be better off going elsewhere.

Regardless of which 529 savings plan you choose, you can withdraw the money tax-free for expenses incurred at any eligible school in any state, and even for certain international schools.

Anyone can open a 529 savings plan and name anyone else, including himself, as the beneficiary. You can also change the beneficiary later on, as long as the new beneficiary is related to the old beneficiary.

In short, 529 savings plans allow you to save and invest for future education expenses in a tax-advantaged way.

Prepaid tuition plans vs. savings plans

In addition to 529 savings plans, some states also offer prepaid tuition plans that may be advantageous in certain situations.

Prepaid tuition plans allow you to buy units that each typically cover 1% of one year’s worth of college tuition at a public, in-state university. This essentially allows you to lock in the current cost of college, protecting you against the risk that tuition costs will continue to rise.

“The huge part of a prepaid tuition plan is that it’s guaranteed,” said Angie Furubotten-LaRosee, fee-only CFP and founder of Avea Financial Planning. “With a traditional 529 plan you have to worry about market fluctuations, and with these you don’t.”

There are downsides, though. The biggest of which is that while you can usually get your money back if your child wants to go to a private college or go out of state, the return is typically much smaller than what you would get from attending an in-state public school.

This is in contrast to a 529 savings plan, which allows you to use the money you’ve earned at any eligible institution.

“Prepaid plans are ideal for parents who have a good idea of where their child will attend college and who are willing to give up investment flexibility to lock in those costs,” said Kathleen Boyd, CFP and wealth adviser at Navigoe. “However, if you’re uncertain about your child’s future college plans, then a 529 savings plan may be the ideal option.”

Benefits of a 529 savings plan

1. Tax breaks

The tax breaks are the main advantage of 529 savings plans over other savings and investments accounts.

The growth and the ability to withdraw the money all tax-free for qualified education expenses mean that every dollar you contribute can multiply faster and cover a greater portion of your education expenses.

And if you live in one of the states that offers a state income tax break for contributions, you can potentially afford to make a bigger contribution without affecting your monthly budget, allowing you to get an even bigger head start.

“If you are in a state that offers good benefits, and some states even offer matching funds, it really is the right choice at that point because you aren’t going to get those benefits from any other option,” said Nannette Kamien, CFP and principal of Inspiration Financial Planning, a fee-only financial planning firm with expertise in helping families prepare for college financially.

2. High contribution limits

If you’d like to save a lot of money for education, a 529 savings plan will allow you to do it.

There is no annual contribution limit, though contributions are subject to gift tax rules, which means that you can effectively contribute $15,000 per year, per child, without exceeding the 2018 gift tax exemption. That limit is applied per donor, meaning that parents can combine their limits to contribute up to $30,000 per year, per child.

The tax code also allows you spread excess contributions over a 5-year period, meaning that as a couple, you could potentially contribute up to $150,000 in a single year without any gift tax consequences.

Most 529 savings plans do have lifetime contribution limits, but those limits are very high. For example, New York allows you to contribute up to $520,000 to any single beneficiary, and Utah allows up to $446,000 per beneficiary.

Additionally, there are no income restrictions on contributions, so anyone can take advantage of a 529 savings plan no matter how much money you make.

3. Mindset and accountability

One of the biggest benefits of contributing to a 529 plan is that it establishes saving for college as a real goal with progress that can be tracked along the way.

“Just having the 529 plan in and of itself solidifies that it’s an important priority for you and your family,” said Furubotten-LaRosee. “It’s now a budget item, it’s identified as money that’s earmarked for college, and I think that setting that habit is half the battle for a lot of people.”

4. Potential for long-term returns

By offering mutual funds that are invested in the stock and bond markets, 529 savings plans allow you to participate in the long-term, compounding returns that those investments offer. This can be especially powerful if you start when your child is young.

“Families who can invest over the long term are prime candidates for 529s,” said Boyd. “The earlier you start, the more time you have to take advantage of compound returns the markets provide over time.”

5. Low impact on financial aid

Many people are hesitant to save for college because of the potential impact on financial aid, but 529 savings plans have a relatively low impact.

As long as the account is held in a parent’s name, only up to 5.64% of the money in a 529 savings plan will be counted on the FAFSA. For example, if you have $100,000 in your 529 savings plan, only $5,640 will be considered for financial aid purposes.

In other words, there’s very little penalty for having money in a 529 savings plan. And the benefits of saving the money ahead of time will almost always outweigh any small decrease in financial aid.

6. Ability to change beneficiaries

529 savings plans allow a reasonable amount of flexibility when it comes to changing the beneficiary of the funds.

You are allowed to change the beneficiary as often as you like, and the only restriction is that the new beneficiary must be a family member of the old beneficiary. For the purposes of 529 plans, “family members” include siblings and stepsiblings, children, stepchildren, and grandchildren, parents, grandparents, nieces, nephews, first cousins and even in-laws.

All of which means that if the money isn’t needed for the original beneficiary, you can simply use it for another family member.

Pitfalls of 529 savings plans

1. Taxes and penalties if not used for education

The biggest downside to using a 529 savings plan is that if you withdraw money for anything other than qualified education expenses, the earnings will be subject to taxes and a 10% penalty.

This is one reason to be careful about over-contributing, and also to not contribute money that may be needed for other financial goals.

“That’s where that overarching financial plan comes into play,” said Furubotten-LaRosee. “You can always use other vehicles, like a Roth IRA, that come with more flexibility.”

2. Investment options can be narrow and confusing

Each 529 plan offers its own preselected set of investment options, and those options vary widely in terms of what they invest in and how much they cost. Sorting through all of those options and making the best choices for your needs can be difficult.

“Sometimes I see that parents are afraid to really invest the money and they don’t understand what the different investment options mean,” said Kamien. “Sometimes they get stuck in investments that are higher cost, and that really eats into the earnings that they could have gotten.”

Kamien said that she encourages people to look for “age-based index” options. These funds provide an all-in-one portfolio that automatically gets more conservative as your child approaches college, and they build the portfolio with index funds, which are generally low cost and have been shown to outperform actively managed funds the majority of the time.

3. Other financial responsibilities may be more important

While saving for college is a great goal, it’s often a good idea to handle other financial responsibilities first. This is especially important to consider before contributing money to a 529 savings plan because of the taxes and penalties on nonqualified withdrawals.

“I certainly would caution a parent or grandparent against sacrificing their own financial goals like saving for an emergency fund, paying off debt or retirement plans to contribute to a 529 plan,” said Boyd. “Saving for education is very important, but it’s also a luxury and a privilege for your children, and it shouldn’t come above your own financial security.”

How to compare 529 savings plans

When it comes to choosing a 529 savings plan, start by looking at the potential tax breaks offered by your home state’s plan, said Fred Amrein, a college funding expert and the founder of EFC Plus.

“You need to understand your in-state plan first, and if the beneficiary is in another state you need to understand their state’s plan next,” Amrein said. “In some cases, it may be more beneficial to gift the money to the beneficiary or the beneficiary’s parents and let them contribute the money.”

Even if your state does offer tax breaks, it’s not a given that your home state’s plan is the best option. There are a few more major variables you should consider as you compare 529 savings plans.

Here are the criteria we used to construct our list of best 529 plans.

Out of state

We evaluated each 529 savings plan from the perspective of an out-of-state resident. That means that state income tax breaks were not considered and that any 529 plans that are unavailable to out-of-state residents were ruled out.

Fees

Research has shown that cost is the best predictor of future investment performance, with lower costs leading to better returns. For that reason, we preferred 529 plans that minimized both investment and administrative fees.

We also filtered out adviser-selling 529 plans, which are specifically designed to be sold and managed by financial advisers and have higher fees in the form of commissions and management fees. Given that financial advisers can also advise on 529 plans that are sold directly to the consumer, and therefore cost less, we limited our search to those direct-sold plans.

Investment options

Investment portfolios built with index funds have been shown to outperform actively managed portfolios 80%-90% of the time, and we therefore only included 529 savings plans that offer index funds.

We also limited our list to 529 savings plans that offer age-based portfolios constructed with index funds, since these all-in-one portfolios simplify the investment process and automatically decrease your investment risk as your child nears college age.

Finally, we preferred 529 savings plans that offered access to individual index funds that allow investors to build custom portfolios if they so choose.

Minimum investment

Finding room in your budget for college savings can be difficult, so we did not consider any 529 savings plan that required a significant minimum investment.

None of the plans listed below require more than a $50 initial investment.

Other features

While most 529 savings plans offer most of the same basic features, we did consider additional features offered by certain plans that may be helpful for some investors.

The nine best 529 savings plans

Fidelity Arizona College Savings Plan

Arizona’s College Savings
Arizona’s College Savings Plan is managed by Fidelity, just like Delaware, Massachusetts and New Hampshire, which also appear on this list. Each of these states offers essentially the same plan.The index funds are high quality and low cost, and there are no other significant fees, though the presence of higher-cost actively managed funds could lead some people to pay more than they have to.

  • Investment options: Age-based portfolios constructed with Fidelity index funds, as well as access to individual Fidelity index funds if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.13%-0.16% per year. Individual index funds range from 0.13%-0.18% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $50 otherwise.
  • Other features: None of note.
  • Website: https://www.fidelity.com/go/529-arizona/overview

California ScholarShare 529

ScholarShare 529
Managed by TIAA-CREF, California offers a selection of both index funds and actively managed funds. The lineup of passive age-based funds and individual index funds is strong.
  • Investment options: Age-based portfolios constructed with TIAA-CREF index funds, as well as access to individual TIAA-CREF index funds, if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.11%-0.17% per year. Individual index funds range from 0.08%-0.20% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $25 otherwise.
  • Other features: None of note.
  • Website: https://www.scholarshare529.com

Delaware College Investment Plan

Delaware College Investment Plan

Delaware’s College Investment Plan is managed by Fidelity, just like Arizona, Massachusetts and New Hampshire. These states offer essentially the same plan.

The index funds are high-quality and low-cost and there are no other significant fees. The plan does offer higher cost actively managed funds, which could lead some people to pay more than they have to.

  • Investment options: Age-based portfolios constructed with Fidelity index funds, as well as access to individual Fidelity index funds if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.13%-0.16% per year. Individual index funds range from 0.13%-0.18% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $50 otherwise.
  • Other features: None of note.
  • Website: https://www.fidelity.com/go/529-delaware/overview

Illinois Bright Start Direct-Sold College Savings Program

Illinois Bright Start Direct-Sold College Savings Program
The index age-based funds use Vanguard mutual funds with some of the lowest fees offered by any 529 savings plan. Even the higher-cost “multi-firm” age-based funds cost less than most actively managed funds offered by other plans.

  • Investment options: Age-based portfolios constructed with Vanguard index funds, as well as access to individual Vanguard index funds and DFA funds — a highly respected group of mutual funds that are typically only available through financial advisers — if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.12%-0.15% per year. Individual Vanguard index funds range from 0.10%-0.18% per year. There are no account maintenance fees.
  • Minimum initial investment: None
  • Other features: None of note.
  • Website: https://www.brightstartsavings.com

College Savings Iowa

College Savings Iowa
Every investment offered within Iowa’s 529 savings plan is managed by Vanguard and costs just 0.20% per year. And with a strong lineup of both age-based portfolios and individual mutual funds, you have plenty of room to personalize your investment plan.

  • Investment options: Age-based portfolios constructed with Vanguard index funds, as well as access to individual Vanguard index funds if you’d like to customize your portfolio.
  • Fees: Every investment option costs 0.20% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $25 otherwise.
  • Other features: None of note.
  • Website: https://www.collegesavingsiowa.com

Massachusetts U.Fund College Investing Plan

Massachusetts U.Fund College Investing Plan
Massachusetts U.Fund College Investing Plan is managed by Fidelity. The plan is essentially the same as Arizona’s, Delaware’s and New Hampshire’s.

It offers high-quality, low-cost index funds with no other significant fees, though the presence of higher cost actively-managed funds could lead some people to pay more than they have to.

  • Investment options: Age-based portfolios constructed with Fidelity index funds, as well as access to individual Fidelity index funds if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.13%-0.16% per year. Individual index funds range from 0.13%-0.18% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $50 otherwise.
  • Other features: None of note.
  • Website: https://www.fidelity.com/529-plans/massachusetts

New Hampshire UNIQUE College Investing Plan

New Hampshire UNIQUE College Investing Plan
New Hampshire’s UNIQUE College Investing Plan is managed by Fidelity, just like Arizona, Delaware and Massachusetts. Each of these states’ plans are on this list and are basically the same.

New Hampshire’s plan offers high-quality, low-cost index funds with no other significant fees. However, the plan offers higher cost actively-managed funds, which could lead some people to pay more than they have to.

  • Investment options: Age-based portfolios constructed with Fidelity index funds, as well as access to individual Fidelity index funds if you’d like to customize your portfolio.
  • Fees: Age-based index funds range from 0.13%-0.16% per year. Individual index funds range from 0.13%-0.18% per year. There are no account maintenance fees.
  • Minimum initial investment: $15 with enrollment in automatic contributions. $50 otherwise.
  • Other features: None of note.
  • Website: https://www.fidelity.com/529-plans/new-hampshire

New York’s 529 College Savings Program

New York’s 529 College Savings Program
Like Iowa, New York’s 529 College Savings Program offers only Vanguard index funds and index age-based funds, and in this case, the cost of each fund is even lower at 0.15% per year.

If your priority is minimizing fees and accessing Vanguard funds, this is likely the plan for you.

  • Investment options: Age-based portfolios constructed with Vanguard index funds, as well as access to individual Vanguard index funds if you’d like to customize your portfolio.
  • Fees: Every investment option costs 0.15% per year. There are no account maintenance fees.
  • Minimum initial investment: $0.
  • Other features: None of note.
  • Website: https://www.nysaves.org

Utah my529

Utah my529

Utah’s my529 offers possibly the most noteworthy set of features of any 529 savings plan:

  1. You can create your own age-based portfolio from the underlying funds offered by the plan, which include Vanguard index funds as well as DFA funds that are typically only offered by financial advisers.
  2. If you are working with a financial adviser, you can give him or her access to your 529 plan in order to manage your investments.

The fees are slightly higher than the other 529 savings plans listed here — though they are still very low — but the investment capabilities are second to none.

  • Investment options: A wide variety of age-based portfolios, Vanguard index funds and DFA funds.
  • Fees: Age-based index funds range from 0.169%-0.202% per year. Vanguard individual index funds range from 0.22%-0.40% per year and DFA funds range from 0.37%-0.72% per year. There are no account maintenance fees.
  • Minimum initial investment: $0.
  • Other features: Customized age-based portfolios and financial adviser access.
  • Website: https://my529.org

How to enroll in a 529 savings plan

Once you know which 529 savings plan you want to use, it’s time to open an account and make your first contribution. And while every plan will have a slightly different process, there are a few steps that are likely to be similar across the board:

  1. Have the necessary information ready for the account owner:
    1. Social Security number
    2. Birth date
    3. Mailing address
    4. Physical address
    5. Bank account number and routing number for making contributions
  2. Have the necessary information ready for the beneficiary
    1. Social Security number
    2. Birth date
    3. Mailing address
    4. Physical address
  3. Read the program description, which can be found on the 529 plan’s website
  4. Choose an investment strategy. You can review the options on the 529 plan’s website and in the program description.
  5. Start the application process online or submit the appropriate paperwork.

How to use 529 plans to pay for K-12 private education

The recently passed Tax Cuts and Jobs Act expanded the flexibility of 529 savings plans by allowing investors to withdraw up to $10,000 per year, per child tax-free and penalty-free for tuition for elementary or secondary school.

This opens up more opportunities for parents to use 529 funds for their child’s education. But given how new the law is, it’s a good idea to proceed carefully.

According to Amrein, the tax implications of withdrawing 529 money for K-12 tuition are straightforward on the federal side but are yet to be determined on the state side.

“What a lot of states are dealing with is a lot of them had incentive programs for college contributions,” said Amrein. “What I’m hearing is some of the states are either going to withdraw that incentive or, if you use it for K-12 expenses, there may be a clawback provision that they can rescind that tax break you received for previous contributions.”

If you live in a state that offers tax breaks for 529 plan contributions, and if you’ve taken advantage of those tax breaks, you may want to speak to an accountant before using your 529 funds for K-12 tuition.

Alternatives to 529 savings plans

While the tax breaks offered by a 529 savings plan are hard to beat if you’re saving money specifically for education, there are a number of other savings and investment accounts that can be more advantageous, depending on the specifics of your situation.

Here are some of the major alternatives to consider.

Roth IRA

While Roth IRAs are technically retirement accounts, they have a few characteristics that make them attractive college savings accounts:

  • They offer tax-deferred growth while the money is inside the account.
  • You can withdraw up to the amount you’ve contributed at any time and for any reason without tax or penalty.
  • Early withdrawals of Roth IRA earnings used for higher education are taxed but are not subject to the typical 10% penalty.
  • If you don’t need the money for college, you can keep it in the Roth IRA and use it tax-free for retirement.

“I’m a big proponent of incorporating a Roth into college planning, especially when you have a teenager who is hopefully earning money,” said Furubotten-LaRosee. “Starting the savings habit is a biggie, and if you don’t use it for college it’s available for retirement or any other goal.”

The big downsides are that Roth IRAs are not as tax-efficient as 529 savings plans when used for college and that by dedicating your Roth IRA for college savings, you’re using up valuable retirement space.

Still, the flexibility is often worth it.

Taxable investment account

A regular, taxable investment account doesn’t offer any tax advantages, but it does provide maximum flexibility to invest in whatever you’d like and to use the money at any time and for any reason.

“As a parent, sometimes you need flexibility with your money,” said Furubotten-LaRosee. “You need the ability to control things as life progresses, and not having it tied into a 529 plan means you can access it when you need to.”

Coverdell ESA

The primary benefit of a Coverdell Education Savings Account (ESA) used to be the ability to allocate the money for K-12 expenses, but that benefit is much less relevant now that 529 savings plans can also be used for the same purpose.

Coverdell ESAs also come with stricter contribution limits than 529 savings plans. Contributions are limited to $2,000 per year, per child across all contributors. Once your Modified AGI (adjusted gross income with certain deductions like student loan interest added back) exceeds $110,000 for individuals or $220,000 for married couples filing jointly, you can no longer contribute.

According to Amrein, the main benefit of a Coverdell ESA at this point is the ability to choose from a much wider range of investment options than you can get from a 529 plan.

“It’s kind of like comparing a 401(k) to an IRA,” said Amrein. “Most 529 plans are very restrictive, with maybe five to 10 investment options to choose from. On the Coverdell side, you can invest in anything you want, but you’re limited to $2,000 per year.”

Savings account

While a savings account can’t offer the long-term returns that you might get from a 529 savings plan, Roth IRA or Coverdell ESA, it is a simple and safe choice that can make sense either as a starting point or if your child will be starting college soon.

And Furubotten-LaRosee argues that no matter which account you choose, the main priority should simply be to separate your college savings from your regular checking and savings accounts.

“Even if it’s just in a separate savings account, the main thing is having it really separate and earmarked for college,” said Furubotten-LaRosee. “That gives it a little protection from your day-to-day spending.”

Choosing the right 529 savings plan for you

529 savings plans allow you to save a lot of money while being tax-efficient for your child’s education, which can help defray the rising costs of college.

The first step is always understanding your home state’s plan to see what kind of tax breaks are available. Then, you can compare it with other states to determine which 529 savings plan will allow you to minimize costs and access the best investment options.

Finally, you can make your decision within the context of your entire financial plan. Saving for college is a fantastic goal, and 529 savings plans are a powerful way to do it, but it shouldn’t come at the expense of other financial responsibilities.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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How to Use Your Mortgage Cash-Out Refinance

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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If you need money to pay for a big expense — such as college tuition, making home improvements or paying off credit card debt — and if you don’t have the savings to handle it, a cash-out refinance could help.

A cash-out refinance allows you to borrow from the equity you’ve built in your home, often at lower interest rate than other loans, and receive cash that can be used for just about any purpose. It can be a relatively cheap way to borrow money for important expenses.

But there are some risks involved with cash-out refinancing, and in certain situations, the cost will be higher than the alternatives.

This article explains what cash-out refinancing is, and dives into the pros and cons so that you can make the right decision for your needs.

What is cash-out refinancing?

A cash-out refinance involves taking out a new loan that is larger than your existing mortgage so that you can replace your old mortgage and walk away with extra cash that you can use for other financial goals.

For example, if you currently have a $150,000 mortgage on a home that’s worth $250,000, you could potentially refinance into a $180,000 loan that replaces your old mortgage and provides $30,000 that can be used for any purpose.

This is different than a traditional rate and term refinance in which your new loan balance is the same as your old loan balance.

With a traditional refinance, the primary goal is usually to reduce your interest rate and/or reduce your loan term in order to save money and potentially pay off your mortgage sooner.

With a cash-out refinance, the goal is generally both to improve the terms of your existing mortgage and tap into your home equity to help fund other financial goals.

Michael Dinich CRPS, a financial planner and the founder of Your Money Geek, says that a cash-out refinance can be an attractive way to pay for things like home improvements — in which case the interest would likely be tax deductible since the loan would be used to substantially improve the homes — or even pay off higher-interest debt like credit cards. The interest rate on cash-out refinances is usually lower than other forms of debt, such as personal loans or credit cards, because you are using collateral to back the loan (your home).

But there are some things to watch out for as well.

First, a cash-out refinance turns an asset — your home equity — into debt, which is always a decision that should be made carefully.

Second, the cash proceeds are typically first used to pay closing costs and other upfront expenses like property taxes and homeowners insurance, so you won’t always receive the full difference between your new loan amount and your old loan amount. You can apply for a no-cost refinance, but that just means that you’ll receive a higher interest rate or the closing costs will be added to the loan, so there’s really no escaping the cost.

Third, a larger loan could increase your monthly payment, and even if it doesn’t, you may end up paying more interest over the life of your loan if you are extending your loan term.

LendingTree has a slew of tools to help you do the math. You can use this cash-out refinance calculator to estimate your monthly payment and this loan payment calculator to estimate your total interest cost.

So how do you decide whether a cash-out refinance is the right move for you? Let’s first look at how you can qualify and then look at situations in which it may or may not make sense.

How do you qualify for a cash-out refinance?

There are a few criteria you’ll have to meet in order to be eligible for a cash-out refinance.

Credit score

You must have a credit score of at least 620 in order to qualify for a cash-out refinance on your primary home. There are several ways to check your credit score for free, and you can use these six steps to improve your score if it isn’t yet where it needs to be.

Loan-to-value ratio

The maximum allowable loan-to-value ratio for a cash-out refinance is 80%, meaning that your total outstanding home loan balance after the refinance is complete can’t exceed 80% of the value of your home.

As an example, if your home is currently valued at $250,000, your new loan — combined with all other house related debt such as a home equity loan or HELOC — can’t exceed $200,000. If your outstanding debt is already greater than $200,000, you won’t be eligible for a cash-out refinance.

If you are looking to refinance a second home or an investment property, the maximum allowable loan-to-value ratio is lowered to 75%.

If you have a VA loan, you may be able to secure a cash-out refinance even if you don’t meet those loan-to-value requirements, but your maximum loan amount is capped depending on where you live and the type of property you are refinancing.

Debt-to-income ratio

Your debt-to-income ratio is the sum of all your monthly debt payments — including student loans, credit cards, and auto loans, in addition to your mortgage payments — divided by your gross monthly income. It must be 50% or less in order to qualify for a cash-out refinance.

Financial documentation

You will have to provide documentation that verifies your income and assets and proves that you are able to afford the loan. This documentation will vary by lender but often includes at least the following:

  • Your two most recent tax returns
  • Your two most recent W-2s
  • Bank statements for the past two months
  • Investment statements for the past quarter
  • Pay stubs from the most recent month

How those factors affect the cost of a cash-out refinance

While meeting the minimum requirements should allow you to qualify for a cash-out refinance, you can save money by improving these variables.

Specifically, lenders may collect a surcharge that varies based on your credit score and loan-to-value ratio.

If your credit score is 680 or above and your loan-to-value ratio is 60% or less, you can avoid the surcharge. But if your credit score dips below that threshold or your loan-to-value rises above it, your fee will range from 0.25%-3% the value of your loan.

For example, let’s say that your home is worth $250,000, your current mortgage balance is $150,000, and you’d like a cash-out refinance for $200,000 — an 80% loan-to-value ratio — so that you have $50,000 available for other goals.

If your credit score is between 700 and 739, you’ll face a 0.750% surcharge that equates to $1,500.

But if your credit score is just a little bit lower at 680-699, you’ll face a 1.375% surcharge that equates to $2,750. That’s an extra $1,250 for potentially just a few points difference in credit score.

All of which is to say that getting yourself in peak financial condition will help you qualify for a cash-out refinance and make it less costly.

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Good ways to use your cash-out refinancing

There are many different ways you can use your cash-out refinance, some of which could help you improve your financial situation, save you money and even increase the value of your home.

Here are a few good ways to use your cash-out refinance.

Home improvements

Certain home improvements, such as replacing your entry door or upgrading your kitchen, can increase the value of your home in addition to making it a more enjoyable living space. And if you don’t have the savings to pay for it outright, using a cash-out refinance to fund those improvements can be a smart move.

“It may make sense to tap home equity for home improvements because the interest rate is lower than other forms of borrowing”, said Dinich.

Another benefit of using a cash-out refinance to improve your home is that the interest should be deductible. Under the Tax Cuts and Jobs Act, only interest on home loans used to buy, build or substantially improve your deductible, and home improvements should fit the definition.

It’s worth noting though that not all home improvements will increase the value of your home. Pools often don’t represent a good return on investment, and you also need to be careful about upgrading your home too far above the rest of your neighborhood.

This is one area where it pays to do your research. A good decision can pay off, but an uninformed decision may cost you money.

Paying off high-interest debt

Because the loan is secured by your home, and because it’s considered a first mortgage, a cash-out refinance typically has lower interest rates than other forms of debt.

This not only makes cash-out refinancing an attractive option compared with other loans, but it can make it a good way to pay off other loans and save some money in the long-term.

If you have credit card debt or private student loan debt with high interest rates, for example, you may be able to reduce your rate by executing a cash-out refinance, pay off those other loans and reduce your interest charges going forward.

Proceed carefully when it comes to federal student loans though. Those loans have a number of protections — such as income-driven repayment, forgiveness and deferment and forbearance — that would be lost by refinancing. Those protections are often worth more than a lower interest rate.

It’s also worth noting that the interest charged on the portion of the new loan used to pay off debt would not be deductible since that part of the loan wouldn’t be used to buy, build or substantially improve your home.

Paying for college

With college costs on the rise, parents are forced to get creative when the tuition bills come due.

A cash-out refinance may offer a lower interest rate than other types of loans, including parent PLUS federal student loans that are currently issued with a 7% interest rate.

The big downside is that you are using your house as collateral and that you will still be responsible for the loan even if your child drops out or otherwise doesn’t finish his or her education. You are also adding to your personal debt load at a time when you may need to be ramping up retirement savings.

In many cases it will make more sense for your child to take out federal student loans. They offer more protections, and he or she will have decades to pay it off.

Still, this can be an effective strategy in the right situations.

Purchasing an investment property

Using your cash-out refinance to purchase a rental property could serve as an effective long-term investment. The cash flow produced by the rental income could both offset the costs of the refinance and serve as a helpful source of income, and purchasing the property with the proceeds from a cash-out refinance may be cheaper than other forms of borrowing.

“It’s generally less expensive for homeowners to borrow against their primary residence than to borrow for an investment property,” said Dan Green, the founder of Growella and branch manager for Waterstone Mortgage in Cincinnati. “A cash-out refinance on the primary residence can reduce the total interest costs against both properties.”

Risks associated with a cash-out refinance

While a cash-out refinance can be a smart move in the right circumstances, there are some risks as well and in some situations there could be severe financial consequences.

Here are some of the riskier ways to use a cash-out refinance.

Debt consolidation

While using a cash-out refinance to pay off high interest can look like a no-brainer on the surface, there are some significant risks to be aware of.

“Accessing home equity to pay off high-interest credit card debt can be a good strategy, but only when it is in conjunction with the creation of a sustainable spending plan”, said Justin Harvey, a fee-only financial planner and the founder of Quantifi Planning, LLC in Philadelphia.

That is, taking out new debt to pay off old debt is generally only effective if you have a strong budget in place and a sustainable plan to both repay and stay out of debt. If replacing your credit card debt simply frees up space to reload those same credit cards, you could be doing more harm than good.

“Some of the consumers who were most harmed by the 2008 economic collapse were homeowners who treated their primary residence like an ATM during the housing price run-up,’ said Harvey. “When the price correction followed, many were stuck with a high-dollar mortgage on a low-value asset, and some homeowners were even underwater.”

Investing in the stock market

Taking out a loan to invest in the stock market is rarely a good idea. Stock market returns are not guaranteed, especially in the short term, and it’s possible to lose a lot of money in a short period of time.

If your investments do lose value, you may not have the money needed to make your mortgage payments, in which case you could be at risk of foreclosure.

Buying a car

“Taking out money to buy a car might not be a good way to use your equity,” said Jeremy Schachter, branch manager at Pinnacle Capital Mortgage in Phoenix. “You take out that equity and roll the interest over a 30-year period or take maybe a higher interest rate auto loan at a shorter term.”

Interest rates on auto loans are often low, especially if you are buying a new car and/or have excellent credit. And the loan term is typically one to eight years, which is shorter than most home loans and therefore often leads to lower interest costs over the life of the loan even if your interest rate is higher.

Starting a business

Only about half of all new businesses survive five years or longer, and only a third make it to 10 years or more. That’s less than the length of a typical mortgage, which means that you could run into trouble making your loan payments and put your house at risk in the process.

“Not all business loans are secured loans and all mortgage loans are,” said Green. “When your business succeeds, the distinction is less relevant. But when your business fails, having an unsecured loan is an advantage.”

If you do need a loan for your business, here are some alternatives to consider: 17 Options for Small Business Loans.

Lending money to friends and family

Lending money to friends and family is always risky because if the deal goes south, your personal relationship could be in jeopardy.

Financing that loan by taking on new debt yourself adds to the cost and risk of the transaction. And by tying that debt to your house through a cash-out refinance, you’re putting yourself in a position where if your friend or family member can’t pay you back, you could end up losing your home.

Put simply, this is rarely a good idea. If you’re determined to do it though, Green says that you should approach it like you would any other business decision.

“If you’re lending to friends or family members,” Green said, “you should use the same due diligence as with any investment and charge an appropriate interest rate for the risk.”

Should you use a cash-out refinance?

A cash-out refinance often has a lower interest rate than other types of loans because it’s secured by your home and because it’s considered a first mortgage. That can make it an attractive way to pay for big expenses, especially if you can reduce the interest rate on your existing mortgage in the process.

But that debt comes at a cost and it’s always worth evaluating all of your options, from saving the money you need yourself to exploring other types of loans.

In the end, a cash-out refinance is just one tool of many. When it’s used thoughtfully, it can provide a good return on investment. When it’s not, it can be just another costly debt.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
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Matt Becker is a writer at MagnifyMoney. You can email Matt here

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Can I Refinance a Mortgage When My Home Is for Sale?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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If you’re having trouble paying your bills, or if you’d simply like to reduce your monthly expenses, refinancing your mortgage could be a good option. By reducing your interest rate, extending your loan term, or both, you could stand to significantly reduce your monthly payment.

But refinancing isn’t easy if you’re also in the process of selling your home. Many mortgage lenders may be hesitant to work with you, and there are some rules you’ll have to follow before you can even consider it.

This article explains why you might want to refinance your mortgage while your home is for sale, why lenders might be hesitant to allow it, and how you can maximize your odds of success.

Why You Might Consider Refinancing When Selling Your Home — and Why You Should Think Twice

There are a few situations in which refinancing a home you are trying to sell might seem like a good idea. But there are also some downsides to this approach, and in some situations, those downsides will outweigh any potential benefit.

Here are some of the reasons to consider it, as well as some reasons to think twice.

1. Relieve the burden of two mortgage payments

If you have already moved into a new home and you are now dealing with two mortgage payments, refinancing your older mortgage could be a way to reduce your monthly expenses and make this temporary situation a little more manageable.

One issue with this approach is that the upfront closing costs could outweigh the savings you receive on the monthly payment. This is especially likely if you end up selling your home quickly, as there may not be enough time for you to recoup those upfront expenses.

Dan Green, the founder of Growella and the branch manager for Waterstone Mortgage in Pewaukee, Wis., also warns that refinancing is not a cure-all if you’ve gotten yourself into a difficult financial situation. While it may offer temporary relief, the long-term issue of having to afford two mortgages will remain and you might end up spending a lot of money on something that still leaves you in a tough spot.

2. You can do a no-cost refinance

If you plan on selling your home within the next few months, the typical upfront closing costs associated with refinancing are a big obstacle.

But you may be offered a no-cost refinance in which you’re able to refinance your mortgage without closing costs. And that could be helpful in the right circumstances, as long as you understand the pros and cons.

The term “no-cost” is slightly deceptive because the lender isn’t actually giving you a free pass. They are simply rolling the closing costs into the loan, which increases the amount you’re borrowing and therefore increases the long-term cost of the loan.

The upside is that without the upfront costs, you can start saving money immediately as long as you’re able to lower your monthly payment. If you sell your home relatively quickly, you could end up spending less than if you had kept your original mortgage.

The downside is that since you’re taking out a larger mortgage, you’ll have to pay more the longer you hold it. If you have trouble selling the house or if your plans change and you decide to keep it, you could end up spending more than you would have either with your original mortgage or with a traditional refinance.

3. You’re not planning to sell the home anymore

If your house has been on the market for some time without any success, you might be having some doubts. That may be especially true if you’re in a buyer’s market, leaving you with little leverage for getting the price that you want.

In that case, you might simply decide that you no longer want to sell the house. You may even decide to turn the home into an investment property instead and rent it out to tenants.

According to Green, this is the most suitable reason to refinance while your home is for sale. If your plans have changed, a refinance might be the best way to save money over the long term.

Why lenders are wary of refinancing a home that’s for sale

Even if you decide that refinancing is the right move, you may have trouble finding a lender that’s willing to do it.

Lenders always take on risk when originating a mortgage loan, and some of these risks are even bigger when they’re considering short-term financing.

Default risk

Default risk is the risk that you might not be able to pay the loan back, in which case the lender stands to lose money.

On the one hand, if you are refinancing a mortgage on a home that you are trying to sell, it should theoretically be a short-term loan and that may decrease the odds of default.

If, as Green mentions, you are refinancing in an attempt to relieve some of the stress of a difficult financial situation, you might quickly find yourself in even more financial trouble if you aren’t able to sell your home quickly. And that type of situation could make it harder for you to pay back the loan, which increases the lender’s risk of losing money to default.

Early-repayment risk

According to Casey Fleming, mortgage adviser and author of “The Loan Guide”, lenders make most of their profit when they sell their loans to investors. So in a situation where you’re trying to take out a loan on a property that you’re trying to sell, the lender faces the risk that you’ll pay the loan off early and eliminate their ability to sell it for a profit.

“A lender doesn’t want to book a loan that’s going to be paid off after only a month or two,” said Fleming. “The lender stands to lose quite a bit of money if someone takes out a loan and then sells the property.”

Even if the lender does manage to sell the loan to an investor, part of the sale includes representation and warranties that could cause problems in the case of early repayment.

Fleming said, “The lender represents to the investor that the information in the file is true and correct and affirms that the loan will pay off as planned.”

So if you sell the home and repay the loan within just a few months, the lender may be forced to buy the loan back from the investor, resulting in more losses.

How to improve your odds of refinancing

If you’re still convinced that refinancing is the right move, how can you find a lender who is willing to go through with it while your home is still for sale?

The first step is to be honest. If your home is listed, it will show up on a multiple listings service (MLS) that the lender can easily cross-reference, so you shouldn’t try to hide it.

Beyond that, here are three steps you can take to improve your chances of getting approved for a mortgage refinance.

1. Take your home off the market

Most lenders will require that you remove your listing before they consider refinancing.

For cash-out refinance transactions, Fannie Mae, a government-sponsored enterprise that buys mortgages from lenders, requires that your property must be taken off the market before the loan is disbursed. And for limited cash-out refinance transactions, they require that the borrower confirm their intent to occupy the home.

In other words, for the most part you will not be allowed to refinance your mortgage if you are still planning to sell the home. You must have changed your mind, decided to hold onto it, and taken it off the market.

2. Write a letter of intent

Even if you do take your home off the market, lenders may still be wary of proceeding. In that case, a letter explaining your new intentions may help you secure the refinance you’re looking for.

According to Green, Fannie Mae requires borrowers to sign a letter indicating their intention to occupy the home as a primary residence. In other situations, you might write a letter explaining that you’ve decided to turn the home into a rental property rather than sell it.

Whatever the case, explaining your intention to hold onto the property, and providing evidence of that intention if possible, could help your case. For example, a copy of a lease agreement with a tenant could bolster your case that you are truly planning on using the property as a rental.

Again, it’s important to be honest. If you declare your intention to keep the home and then turn around and sell it right away, you could end up in a lot of trouble.

“If you misrepresent your intentions, you’ve committed mortgage fraud,” said Fleming. “The lender could sue you for damages and the federal government could prosecute you.”

3. Shop around

While most lenders will require that you take your home off the market and leave it off the market in order to refinance, some don’t have those restrictions.

“Banks or credit unions that retain some of their loans rather than sell them might be more willing,” said Fleming. “But only on higher-risk, higher-rate loans.”

If you shop around, you may be able to find a lender who’s willing to refinance even if you keep your home for sale. But there’s no guarantee, and you’ll likely end up with a more expensive loan that could hurt you in both the short and long term.

A good place to start shopping refi offers is through MagnifyMoney’s parent company, LendingTree’s mortgage marketplace.

The Bottom Line

If your home is already listed for sale, or if you plan on selling in the near future, refinancing is a difficult proposition. Many lenders won’t even offer a refinance unless you take your home off the market and those that will refinance often charge you higher interest rates.

In the end, it may be better to simply avoid refinancing if a sale is imminent.

But if you’ve had trouble selling your home and you’re having second thoughts, you can improve your chances of getting approved by taking your home off the market and refinancing in good faith.

Doing so could help you secure a lower monthly payment, a lower interest rate, or both, and free up a little extra cash flow for your other needs.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Matt Becker
Matt Becker |

Matt Becker is a writer at MagnifyMoney. You can email Matt here

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