Home Equity Loan To Pay Off Student Loans
Are you a homeowner looking for a new way to pay off your student loans?
If so, you’ll love this blog! We’ll explain how to use your home equity loan to pay down your student debt.
Home equity loans are very different from the kind of loans you might take out at the bank. In fact, they’re not even technically called “loans”—they’re more like credit lines that allow you to borrow money against the equity in your home. Your lender will act as an intermediary between you and your lender, who holds the actual mortgage on your property. It’s a good idea to shop around for both lenders and rates before settling on one.
With a home equity loan, you can borrow up to 80% of the value of your home (up to $500K) or 90% if there is an elderly or disabled person living in it. You can use this money for any purpose—even paying off student loans!
Home Equity Loan To Pay Off Student Loans
If you just graduated with student loan debt, you may be wondering how you’re going to pay it all off. If your parents are willing to back you, one option might be to use their home equity loan or line of credit since home equity interest rates are generally lower than student loan rates. The better home equity rates are an enticing offer since they mean you may have more affordable monthly payments.
However, student loans are structured to make repayments more feasible for recent graduates. You’ll want to review both the risks and rewards before transitioning from student loans to home equity borrowing options.
If your parents decide they want to help you repay your student loans with a home equity line of credit, you’ll probably want to set up a repayment system. Consider drawing up a loan agreement between you and your parents outlining how long it will take you to pay them back and what your monthly payments will be.
Consider the benefits of repaying student loans with home equity
First, look into any federal student loan forgiveness programs you may qualify for and how your private student loan rates are structured. If you consolidate your debt with a home equity loan, you’ll forfeit federal forgiveness opportunities. Meanwhile, paying off private student loans with a home equity line of credit may provide lower interest rates and a reduction in the number of payments.
If you have private student loans with a variable interest rate, paying them off with a home equity loan provides the opportunity to move from a variable rate to a fixed rate. Using a home equity line of credit would keep your interest rate variable but may provide you with a lower rate which could be beneficial if interest rates remain low.
If you have been out of college a few years and have built up equity in a home, you could borrow on your own home equity instead of your parents’ home equity. You would be able to consolidate your debt in your own name and only worry about repaying your lender rather than your parents. This allows you take care of the last few years of student debt with a lower interest rate.
Be aware of the risks when transitioning student loans to home equity loans
While the benefits of low home equity rates are appealing, it’s important you and your parents understand the risks that accompany this decision. Even if you have worked out a repayment plan with your parents, it’s important to identify the factors associated with this borrowing structure that could affect their credit and financial situation. Be sure to work with tax professionals regarding the IRS rules for loans to family members and managing interest income as well as tax considerations for gifts. Below are other risk factors associated with paying student loan debt with home equity loans or lines of credit:
- Your parents’ credit scores may go down due to increased utilization of their available credit.
- If you use a home equity line of credit (HELOC) rather than a home equity loan, be aware that it has a variable interest rate. This means the home equity rate fluctuates with the market, and while it may start out low, it could rise during the term of the loan.
- A HELOC requires interest-only payments during the initial draw period, usually 10 years. Then, payments of both principal and interest are required on the remaining balance for a term of 15 years. This payment increase at the end of the draw period may not be beneficial to your parents.
- Your parents’ home serves as security for a home equity loan and may be at risk if they default.
- You forfeit any tax deductions available on student loans. However, your parents may be able to get tax deductions on a home equity loan or line of credit.
- Many student loans grant you the ability to make early payments without penalty. Home equity loans and lines of credit may not have the same conditions.
Borrow off your home equity with a trusted lender like Citizens
If you decide to apply for a home equity line of credit to pay back your student loans, start the application process with a reputable establishment like Citizens. We understand your lending needs and will help you choose the best option to manage your debt. Talk to a Citizens Home Loan Originator to learn more about home equity rates.
home equity loan vs student loan
Paying for college can be a challenge for many families. Even those who are diligent savers may still need more funds after applying available savings, scholarships and grants and maximizing federal direct student loans. In such cases, many parents consider additional loan options like private student loans, the federal Parent PLUS loan or a home equity loan to fill the gap.
Home equity loans allow homeowners to take out a line of credit against the value of their home beyond what they owe on their primary mortgage. Unlike a cash-out refinance, a home equity loan doesn’t replace the mortgage you currently have, and it allows you to borrow the exact amount you need to cover the cost of college, in some cases without having to pay closing costs.
In recent years, property values in many markets have risen dramatically, putting many homeowners in a position to use this financing vehicle.
At the same time, higher interest rates on the Parent PLUS loan could make alternative financing options, like private student loans or home equity loans, more attractive to many families.
The U.S. Department of Education recently raised the Parent PLUS loan interest rate to 6.28% for loans first disbursed on or after July 1, 2021 and before July 1, 2022 – up from 5.3% the prior year. Current home equity loan rates generally range from about 3% to 12% depending on the lender, loan amount and creditworthiness of the borrower.
Pros of a Home Equity Loan to Fund College
Creditworthy homeowners may be able to get home equity loans with a better interest rate than the Parent PLUS loan. The Parent PLUS has the same fixed interest rate for every borrower regardless of credit history, but those with good credit can often find better interest rates on a home equity loan.
Lower interest rates can mean that parents may have lower monthly payments and save money over time as their student’s loan is repaid.
For example, in 2021, the average Parent PLUS loan borrower owed nearly $29,000. The loan’s origination fee currently is 4.228%. At 6.28% interest, the repayment for $29,000 under a standard 10-year repayment plan would be about $326 per month. That includes about $10,126 paid in interest. Adding the total of about $1,226 in origination fees that were automatically taken from each loan disbursement would make the total cost of the Parent Plus loans about $40,350.
If that same parent borrowed a home equity loan for the same amount with a 5% interest rate, the payments would be about $308 per month over 10 years. For a loan with no origination fees, the total cost of the loan would be $36,960, or more than $3,000 cheaper than the Parent PLUS loan.
Be sure to look for home equity loans that charge no closing costs or annual fees. Also keep in mind that better interest rates will depend on your credit score.
In addition, home equity loans also can be the more tax-efficient option for parents. On federal income tax returns, a parent can deduct up to $375,000 in interest annually for qualifying home equity loans – or $750,000 if filing jointly – compared to a maximum of only $2,500 annually for qualifying Parent PLUS loans.
Risks of a Home Equity Loan to Pay for School
If you can save money and reduce your monthly payments by taking out a home equity loan over a Parent PLUS loan, paying for college with a home equity loan may seem like a no-brainer. But parents should be aware that there are more risks associated with these loans.
First, when parents borrow against their homes, they are essentially gambling their homes to pay for school. That’s because when you take out a home equity loan, your home is put up as collateral. If a loan isn’t repaid, your house can be repossessed.
There is also the risk of becoming “upside down” on the home if property values decrease. This occurs when more money is owed on the home than it is worth. If the housing market weakens and your home value drops, you could end up with more debt than equity.