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Helping out the kid
To help someone out, is paying off some kinds of debt better than others?
January 16, 2004: 11:20 AM EST
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - My husband and I would like to help out our son financially. He has about $14,000 in school loans with a 10-year term and a 4 percent interest rate, and has also just bought a new car that will cost him loan payments of $300 a month for the next five years. We're thinking of paying off either the school loan or the car loan. Which do you think we should do?

óLaura, Haymarket, Virginia

In some ways, what you've got here is a toss up. Whichever route you go, you'll certainly achieve your goal of helping out your son financially by taking one of these obligations off his hands.

And in terms of dollars, the two choices are pretty close there too. Pay a school loan of $14,000 or a car loan of $15,000 to $16,000 (the amount assuming a $300 monthly payment and an interest rate in the 6 percent to 8 percent range).

Normally, my instinct would be to tell you to pay the school loan. Why? The expense of a college education is basically a one-time thing. So in paying off this loan you're saying you're willing to help out your son one extraordinary item, much as you might provide financial assistance to help a friend or relative get back on his feet after a rough patch in his life.

The message would be that you're helping out this once so you can cope on your own.

Paying the car loan, on the other hand, would be more like taking on an ongoing living expense. I would be wary of doing that since I think your son -- or, for that matter, anyone starting out in life -- has to learn how to make spending decisions in light of their overall financial situation.

Want an expensive car with lots of glitzy options? Fine. That means you'll have less money for other things, such as clothing, a home and retirement savings. The only way we can truly learn to evaluate these tradeoffs is by making decisions and paying the consequences --that is, making the monthly payments and living with the effects of those payments.

But there's a little twist here that I think you should take into account. While your son can't deduct interest on a car loan, current law does allow him to deduct the interest on a qualified school loan he's legally obligated to pay. (For details on what constitutes a qualified school loan, the maximum deduction allowed, how income affects deductibility and other issues, see IRS Publication 970: Tax Benefits for Education, which is available at the IRS Web site.

So, since I hate to see a good tax deduction go to waste, I think that in this case it would make more sense to help your son pay off the car loan. This way your son can continue paying the school loan and get the benefit of the interest deduction, which lowers the after-tax interest rate on the loan.

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That said, I also think it wouldn't hurt to sit down with your son and discuss some of the budgeting and spending issues I've raised above, if for no other reason than to be sure he understands that your gracious gesture is not a signal that old Mom and Dad are ready to underwrite his lifestyle on a continuing basis.

In short, let junior know that, in recognition of his fine work in college or whatever, you've decided to pay off his school loans. But also make it clear that this is strictly a one-time deal and that, from now on, he's on his own financially.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He also answers viewers' questions on CNNfn's Money & Markets at 4:40 PM on Mondays.  Top of page

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