When you’re struggling to pay for college or eager to repay student loan debt, tapping into home equity may seem like a great option. But, there are pros and cons to consider that you need to understand before you move forward.
The following information can help you understand everything you need to know about how to use home equity to pay off student debt – and whether doing so is a smart idea.
How Can You Use Home Equity to Pay Off Student Debt or Pay for School?
Using home equity to pay off debt is a possibility only if you have equity in your home. You have equity if your home is worth more than you owe on it. If you have a $200,000 home and owe $180,000 on it, you have $20,000 in equity.
You can tap into your home equity by:
Taking a cash-out refinance loan:A cash-out refinance involves taking out a new mortgage for more than you currently owe. You’d use the loan proceeds to first pay off your existing mortgage loan and then use the extra cash you took out to pay for school or pay off student loan debt.
Taking out a home equity loan:Home equity loans allow you to access equity without changing your current mortgage. You’d borrow a fixed amount of money and could use the loan proceeds to pay off your student debt or pay for school.
Taking out a home equity line of credit:Home equity lines of credit allow you to borrow up to a set amount of money, which is called your line of credit. You don’t have to borrow the whole amount at once, and as you pay back what you’ve borrowed, you can borrow more. Again, you’d use the money available on your line of credit to cover school costs or repay existing student debt.
Typically, lenders won’t allow you to borrow up to the full value of your home. Many lenders would prefer you keep your combined total mortgage debt at 80 percent of what your home is worth. So, if you had a $200,000 home, the maximum total balance on your mortgage and home equity loan or line of credit would be $160,000.
However, some home equity lenders allow you to borrow as much as 85 percent of the value of your home. But, you’d usually pay a higher interest rate and need good credit to qualify for this type of loan.
Advantages of Using Home Equity to Pay for College or Pay Off Student Loans
There are some definite advantages to taking out a home equity loan in order to pay for school or repay student loan debt:
You may be eligible for a lower interest rate:Home mortgages and home equity loans are secured debt, so you can usually qualify for a lower rate than on student loans.
You may be able to repay your loan over a longer time:Home equity loans and mortgage loans could have repayment terms that span as long as 30 years. Most private student loans need to be repaid in five to 15 years although there are a few lenders that allow a longer repayment timeline. Being able to pay your loan off over a longer time can result in lower monthly payments.
You’ll have fewer payments to make:If you can tap into enough equity in your home to repay and consolidate multiple existing student loans, you won’t have as many creditors to deal with or as many monthly payments to make. This can simplify your life significantly, and reduce the chances you’ll forget a payment.
Disadvantages of Using Home Equity to Pay for College or Pay Off Student Loans
Unfortunately, there are also some major disadvantages to using home equity to pay for school or student debt. Some of the downsides include the following:
Home equity debt is only tax deductible if it’s used for home improvements:You cannot deduct interest on home equity loans or lines of credit you used to pay for school or pay off student loans. But, if you take out student loans, you are entitled to deduct up to $2,500 in interest annually — even if you don’t itemize on your taxes — provided your income isn’t too high.
You’re putting your home at risk:If you can’t pay back a mortgage, home equity loan, or line of credit, your home could be foreclosed on.
You could end up underwater on your home:If you tap into your home equity, you could end up owing more than your home is worth. This would make it difficult or impossible to sell your house because you’d need to bring money to the table to repay the balance of your loan. If you couldn’t, you’d be unable to sell unless your lender was willing to agree to a short sale – which is very damaging to your credit score.
You could lose out on borrower protections:If you use home equity to pay off federal student debt, you lose the opportunity to put loans into forbearance or deferment to pause payments if you go back to school or suffer financial hardship. You also lose the flexibility in repayment plans that federal loans offer, and will no longer be able to get the debt forgiven through the Public Service Loan Forgiveness Program.
All of these factors are major downsides to using home equity to pay off student loans or using home equity to pay for college instead of taking out federal or private loans.
Should You Tap Into Your Home Equity to Pay for School or Repay Your Debt?
Every situation is different. If you can pay less in interest by using home equity to pay for school or pay off student loans – and you don’t mind the downsides — then it may be worth doing. But, for many borrowers, using student loans or continuing to pay back student debt is a smarter approach.
Another option that you may consider is refinancing your student loans at a lower rate. Both federal and private student loans can be refinanced and consolidated into one new private loan. But just like using your home equity to pay off your student loans, refinancing your student loans carries pros and cons with it, too.
If you’re having trouble making your student loan payments because you have other kinds of debt, like credit card debt, you may want to consider addressing those issues before taking out a home equity loan.
Consolidating your debt with a personal loan from FreedomPlus could help reduce your interest payments and take some financial pressure off you. On the other hand, if you’re dealing with a massive amount of debt, a debt settlement program like Freedom Debt Relief could significantly reduce your debt at a lower monthly cost than your current minimum payments.