You’ve got education loan payments eating into your monthly budget. COVID-19 is dramatically affecting education plans. If your home equity could wipe student debt off your plate, should you go for it?
Should You Use Home Equity to Pay Off Student Debt?
When you feel like you’re drowning in debt, it feels natural to reach toward any solution to your troubles. But using home equity to pay student loans comes with its own serious pros and cons. Financing your home can be risky if you don’t take the time to understand the benefits and potential pitfalls first.
Can you use home equity to pay student loans?
Using a home equity loan for college isn’t an option for everyone. Recent grads who are saddled with debt may not own their own home in the first place, or they may have too low equity to qualify for financing.
In some cases, parents take on education loans (e.g., Federal Parent PLUS loans) to finance their kids’ college tuition. If you’ve been in your home for a while, and you’ve taken out a relatively low parent loan for college, there’s a better chance that you’ll be able to take out enough equity to cover the balance.
Even if you can repay student loans with home equity, whether you should is another matter. Compare home equity options with refinancing or consolidating student loans, and check whether you’re eligible for any student debt forgiveness programs before you take next steps.
Will a home equity loan hurt my credit score?
If you’re considering a home equity loan or a home equity line of credit (HELOC), you may be curious what effect this could have on your credit score.
Generally, the best home equity loans should have a minimal effect on your credit score, as long as you stay on top of payments. It’s common to see a slight dip in the months after you get a loan, but this is usually only about 10-20 points. As you pay back the loan (and lenders see that you’re handling debt well), your score should balance again.
A HELOC can have a positive or negative impact on credit, again depending on your actions. The same smart habits you use with credit cards apply to a HELOC, too. Good credit management can help your score, while missed payments will hurt it.
How student loans build up
Student loan debt affects about 45 million borrowers in the United States. 54% of college attendees took on debt to pay for their higher education. For Parent Plus loans alone, 3.6 million borrowers have $89.8 billion in outstanding debt.
Not all student loan debt is created equal. Federal student loans for undergrads come with a 2.75% interest rate. Parent PLUS loans set a 5.30% interest rate. Private education loans can come with the highest interest rates of all, sometimes climbing higher than 13% (although many private loans also offer qualified borrowers lower rates, too).
Student loan interest often accrues daily. If you have an unsubsidized loan, it may accrue daily even while you’re in school or during a grace period where you don’t need to make payments. It’s no wonder that many graduates struggle to make progress paying off a loan when interest adds to the total balance each day.
How manageable your education loan debt is depends on your interest rate, loan amount, and of course how much you can afford to pay monthly. If some creative refinancing could reduce your overall expenses, then it might make sense to explore paying debt with home equity.
Home Equity Loan vs. Student Debt: Pros and Cons
Home financing and education loans have distinct advantages and disadvantages. Compare pros and cons to decide what makes more sense for you.
Home equity loan pros and cons
Financing your home equity can offer some attractive benefits over dealing with student loans:
- Lower interest: Depending on what kind of student loans you or your child has, home equity financing may come with lower interest. Average home equity loan interest rates vary by state, but 5-6.5% is a common range for HELOC rates. That’s lower than some Federal and many private education loans
- No interest: If you work with a financing partner like Noah, you won’t need to make monthly payments or pay interest at all. That could be ideal if you were planning on selling your home in several years to downsize after your kids are out of the nest.
- Simpler payment: Paying student loans with home equity could leave you with one payment to make, instead of keeping track of multiple loans.
- Lower payments: Home financing may have a longer repayment term, which can lower each monthly payment.
Some important risks to consider before you tap your home equity include:
- You’re putting your home on the line: When you refinance your mortgage, take a home equity loan, apply for a HELOC, or pursue other home financing options, you may agree to put up your home as collateral. If you can’t keep up with payments, you could ultimately lose your home.
- Longer repayment: The lower monthly payment perk above comes with the downside of a longer payment term. If the payment fits comfortably into your budget, this may not be a major disadvantage. Adding years before you’re free and clear from debt isn’t something to take lightly, either.
- Fewer protections: Federal student loans may come with some rights and protections you won’t get with home financing. If you’re planning on going for your master’s degree, it might make sense to keep a student loan that you can defer, instead of committing to a home loan with less payment schedule flexibility.
Student debt pros and cons
Student debt has a few advantages to keep in mind before you make the decision to use home equity to pay the balance:
- Deferral or grace period options: In some situations, you might be able to defer loan repayment (e.g., if you return to school). Most other debt doesn’t come with a “pause” button.
- Loan forgiveness options: Programs such as the Public Service Loan Forgiveness program may cancel some or all of your debt after you make required payments. Some loans can also be discharged if you become disabled and can’t earn income to repay the loan.
- More protection for assets: A student loan shouldn’t put your home at risk, even if you go into default. The Federal government can take your tax refund or garnish wages to repay debt, though, so stay on top of payments.
- Discharge on death: Most student loans will clear if the graduate passes away. Other lenders will still expect repayment, even if the original borrower has died.
The main drawbacks of student loans are:
- Higher debt-to-income (DTI) ratio: Graduates with high student loan debt may struggle to find lenders willing to work with them on a mortgage or other loan. If the DTI ratio is higher than 43%, most lenders cannot give you a qualified mortgage. Many lenders look for a DTI ratio of 36% or less. In other words, paying off all or part of your child’s student loan debt could give them an easier journey to homeownership themselves.
- Rapid interest accrual: Part of the reason student debt is growing so rapidly is the high interest rates on existing loans. It’s alarmingly common for grads to make payments faithfully for years and barely dent their balance, thanks to interest accrual.
Student loan debt is a $1.6 trillion crisis in the United States. If you have the equity in your home to clear student loan debt for yourself or your child, it’s understandable that this could be an attractive option! If you’re able to satisfy a debt and make home payments that fit your budget, this could be a good fit for you. It is important to understand the types of home equity loans and their alternatives. Before you make that move, talk to a financial professional and a home appraisal specialist. Calculating home equity and careful planning is the way to map out your best path toward debt-free life.