(MONEY Magazine) – Q. My wife and I have three-year-old twins. We don't like to invest, so we'd rather use any grandparent gifts to help pay off our mortgage early than have to manage college savings accounts. Is that a bad idea? TODD POLLOCK ERIE, COLO.
A. Afraid so. Yes, prepaying your mortgage reduces your interest costs, but those savings may not be as great as you think, since rates are so low. Say you took out a $200,000 30-year fixed-rate mortgage at a 5.5% rate, and you used a $10,000 gift from the grandparents toward a prepayment. That might save you $30,000 in interest on a 30-year loan. But for someone in the 28% bracket, that represents only a 3.96% return once you factor in your tax deduction on mortgage interest. You have a better shot at keeping up with rising college costs (8% at public universities last year) by investing in stocks and bonds.
The good news: College savings plans are easy to set up and can provide tax breaks. As Colorado residents, you might consider the state's no-load 529 savings plan, which offers low-cost Vanguard funds. You get a state tax deduction on your contributions, and your earnings will be tax-free (assuming Congress extends that status beyond 2010). Since you don't like investing, choose an age-based fund, which adjusts the asset mix from aggressive to conservative as your children grow. Colorado's 529 offers three such options with varying degrees of risk.
Q. What's the difference between EE savings bonds and I bonds, and which is the better buy? SUSAN FARKAS VIA E-MAIL
A. Interest rates are calculated differently for EE bonds and I bonds. EE bonds are issued at 50% of face value and pay an interest rate of 90% of the six-month average of five-year Treasury yields, most recently 3.25%. The bond is also guaranteed to reach face value in 20 years.
I bonds are sold at face value. Interest is calculated in two parts. One portion is a fixed rate of return, recently 1%, which remains steady for the life of the bond. The second is a semiannual inflation rate—the I in I bond—based on the rise in the consumer price index. Today's I bond rate is 3.67%. Both EE bonds and I bonds adjust their rates every May 1 and Nov. 1. So if you're making regular investments, put your money in whatever bond is yielding more at that time.