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College Funding: FAFSA, Financial Independence, and Real Estate

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I recently wrote that college planning is impossible (but that you should do it anyway). The impossibility comes from having a 2 and a (newly) 4 year old boy. It's so far away, the best we can do is put aside a significant amount of money and adjust our plans over time.

One of the comments on that article said it best: The decision tree is enormous.

The College Funding Decision Tree

College may be free if some politicians have their way. College tuition could continue to climb at unreasonable rates forcing people to make hard-decisions about whether it's worth it. Our children may get into some schools and not others. They could be public or private. They could be on a 3-year plan with AP credit and credits from our local college. They could be on a 5-year plan if they switch majors or find it too difficult. All this, and I'm not acknowledging community college or trade schools.

Anything and everything is in play, leading the cost to be literally as low as $0 to as high as $250,000. It seems to make sense to budget for somewhere around $125,000 for each child and let the remaining gap be filled with grants, loans, scholarships, work-study, etc. As another commenter mentioned, many feel it is important for the child to fund part of their own college. I firmly believe in them having some skin in the game.

Financial Independence Makes it A Little Complicated

Regular readers know I am a big believer in the FIRE movement. FIRE is an acronym for Financial Independence/Retire Early. That means you have money freedom before typical retirement age. Money freedom simply means that you've achieved Hakuna Matata... you have no worries about money.

When I started this blog ten years ago, I didn't know such terms existed, but I did know I wanted to get to that place. Years of maxing out retirement accounts, my wife's military pension, and our real estate have fortunately put us in a good position to achieve that.

It's so close that the biggest obstacle is the uncertainty of college costs.

Among all the uncertainty, there's one beacon that represents some stability: The Free Application for Federal Student Aid (FAFSA).

FAFSA and Real Estate

The Free Application for Federal Student Aid (FAFSA) is exactly what it sounds like. It has clear formulas and rules around a family's income and assets. While those rules may change over time, I would expect the changes to be minor ones.

In other words, it's something that can be planned around.

For example, retirement assets don't count. So this person with a hundred million IRA may be in decent shape if he were to fill out the FAFSA. (He's really not.) To an obviously lesser extent, we would be in better shape as well from years of nearly maxing out all our retirement accounts.

Many people who are financially independent get there by discovering that they can live a fulfilling life and be very happy on a smaller income. It's easier than trying to save $10 million dollars. We live that frugal lifestyle as well. Having a small income is a big part of the FAFSA application.

It's like all the pieces are falling into place... except for one... real estate.

One of the legs that supports our financial independence push is real estate. We didn't plan it that way, but my wife separately bought condos in 2002 and 2005 near the top of the market. When we moved so that my wife could serve in San Francisco in 2006 the properties were well under water. Even today, they are valued at between 25-33% less than what we paid for them.

Fortunately, we were able to rent them and over time the mortgages have started to get paid off. We got a double HARP to refinance them both to 15-year fixed mortgages. Despite all that, we lose a little money each month on them (and a lot when repairs are necessary) while we build equity. In about 10 years, before our children are ready for college, we'll have significant real estate assets.

[If you are curious you can read a little more about our real estate "empire" here. (There's a reason why empire is quotes.)]

Overall, I love real estate. I'm not second guessing the decision to keep the properties. The forced savings have really contributed to our net worth.

However, as you may have guessed by now, the FAFSA formula doesn't work well for those with significant real estate assets. If had taken the money we lost each month and truly maxed out our retirement options (there's a lot of small business stuff I can do with SEP-IRAs, solo 401Ks) we'd have "protected" assets from the FAFSA. If we created another business, it's value would also be "protected" from the FAFSA. (And it seems you can't throw the properties in an LLC and call it a business.)

At the most recent FinCon convention, I talked with a number of bloggers. Some were financial independent bloggers. Others were real estate bloggers. I don't think I found one person who fit in all the categories of financial independence, real estate owners, and having children... but I'm sure there are many people out there who fit this profile.

I tried to explain my situation to a few people, but it was difficult. It's taken nearly a thousand words just to paint the picture for you.

I think the correct answer is just to forget about the FAFSA. I have difficulty with that as I like to optimize things in the future. This is the best way for me to look to optimize things.

The other part of me thinks that it might be worthwhile to refinance the 15-year fixed mortgages to 30-year fixed mortgages. Then we'd actually be making money on the properties and we could use it to fund our living expenses which would free me to max out the small business retirement account options. We'd be earning less principle which would make the assets worth less.

Then I stop myself and ask "Is all that worth it for a better FAFSA formula?"

I don't have any answers here. Maybe you do? If so, please let me know in the comments. Thanks!

Posted on October 3, 2016.

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6 Responses to “College Funding: FAFSA, Financial Independence, and Real Estate”

  1. Joe says:

    For you, forget about FAFSA probably will be the easiest thing. You still have almost 15 years left and who knows how the law will change. Why can’t you create an LLC for your rentals? It sounds like a lot of work, but you have 15 years… Refinancing is good now too.

    For us, I think we will slowly move out of the rental property business. It’s good, but it’s a lot of headaches too. I don’t want to deal with renters when I’m 60. We want to travel and not be tied down. We still have a lot of years left so who knows…

    • Lazy Man says:

      The LLC is already being set-up for the rentals. It’s just that an LLC containing investment properties seems to be explicitly rejected as a “business asset” vs. a “personal asset.” (Those quotes are mine, I’m not sure the real terminology, but you get the idea.)

      I imagine we’ll get property managers to eliminate the headaches. They are condos so some of the stuff (landscaping, snow removal) is already taken of. The Reluctant Landlord has some good articles about dealing with rental herself from the other side of the world. If you have property managers, it should be zero headaches. I suppose you could always try it for a year and see how it goes to.

      I’m really thinking about the refinance. I don’t want to the whole financial audit for what will likely be a higher rate (we got them in very low rates after the HARP). On the other hand, it would be good to have lower payments. The tie-breaker might be that those mortgages are with Wells Fargo. I don’t want to have anything to do with them anymore.

  2. *hand raised* SAME.
    I had a disagreement with someone who is convinced he knows money better than I do, and who is convinced that we should be shielding our assets by putting JuggerBaby’s savings into plans held by other people so that we’ll be eligible for aid. Which totally makes sense, someone else should hold our kid’s money and can be trusted not to change the beneficiary or decide to make that disbursement conditional. *eyeroll*

    In all honesty, part of the reason they think it matters is because they have no clue how much money we have or will have. And I’ll keep it that way.

    Meanwhile, in the real world, I don’t have as many properties as you do but so long as we keep up our earnings and savings, we’re going to be well out of the range of FAFSA eligibility in ten or so years.

    And you’re right, who knows what legislation will bring or what we will have available to us by the time our kids are preparing for college?

    I’ve started moving JuggerBaby’s savings into a 529 plan but the reality is, I have no idea if ze will need it or how much ze will need and I’m not sure what we’ll do with the money if ze doesn’t want or need it down the road.

    Joe makes a good point about not keeping up rentals into our old age. If we don’t have to keep managing them and JuggerBaby doesn’t have the inclination to properly manage them, it might be good to have a real estate divestment strategy in our later years.

    • Lazy Man says:

      I’ve never heard anyone say that about a 529 plan. I think only 5-6% of those assets count if they are in the parents’ name. (I presume they didn’t want to people NOT save in 529s which would happen if it would exclude them from getting financial aid.) I could be wrong here as it’s early in my research.

      To the best of my knowledge, savings in retirement accounts and primary residence are exempt. From what I know about you Revanche (and this may have changed since the last time I’ve been updated) that later part could be interesting. One could theoretically “hide” their savings by buying an expensive house to live in and later downsizing. It would be placing a lot of risk in the real estate market which has has its own potential pitfalls, but theoretically possible, I think.

      In the end, I think the answer is just to do nothing other than to continue to save in the 529 plan. I love to optimize though and this investment real estate clause irks me (more than it should.)

  3. I was one of the real estate investors you asked at Fincon with absolutely no idea. The only thing I could come up with is “it’s good you are thinking about this 15 years ahead!”

    I am a big fan of leverage on my rental properties and think extra money is put to better use elsewhere than paying down the mortgage faster. So I would say absolutely refi and put more into the retirement accounts.

    • Lazy Man says:

      Yes, and I might have asked after celebrating the big Patriots win. My apologies if I didn’t word very well (and if I did, score!).

      I think you are probably right about the refi. I’ll have to look at what the rates will be. Psychologically it’s big for my wife to not have the mortgage on the properties eliminate that payment all together. It represents a finish line where paying for all the maintenance and such is worthwhile. (Of course the flip side is that by refinancing, we essentially move up the finish line to now as we’d be making money.)

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