Borrowing against the equity in your home and putting the proceeds into your state’s 529 prepaid tuition plan may pay off, especially if today’s double-digit tuition hikes at many state schools continue into the future. If the value of your 529 prepaid tuition contract increases at a rate in excess of the interest rate on your loan, you end up ahead.
This tactic will be even more attractive if the interest on your loan is tax deductible and the earnings on your 529 contract are tax-free. However, there are a few risks to consider:
Home mortgage loans must be paid monthly but you can’t withdraw money from the 529 plan for this purpose without incurring tax and penalty.
When borrowing on the equity in your home, closing costs can be substantial.
If the prepaid plan is charging a “premium” over current tuition, your overall return will be less than the annual tuition increase.
The payout from the prepaid tuition plan may not be tax-free, depending on future tax law.
Your strategy may negatively impact your child’s eligibility for financial aid in the future.
Home equity currently does not count against the student in the federal aid formula, but 529 plan assets do.