Pursuing multiple financial goals at once is no easy task. But excelling in one area could help you in another. If you find yourself ahead on your mortgage but behind on your college savings, for example, you’re in luck.
A home equity loan (HEL) or line of credit (HELOC) allows you to borrow against your home equity, or the share of your home’s value that you, not your bank, own. That equity could help pay for you or your child’s college education.
You’ll likely want to consider how repayment will work if you plan to use a HEL for continuing your education. For example, a new degree could improve your income, which in turn could help you pay off the extra debt from the HEL. On the other hand, that larger income won’t happen right away, and you’ll have to start making those larger monthly repayments as soon as you take out the HEL.
Whether you’re considering using home equity to pay for college, or as a supplement to a federal or private student loan, weigh the pros and cons below:
- Pro: You could score competitive interest rates
- Con: You could put your credit — and your home — at risk
- Pro: You can borrow beyond student loan restrictions
- Con: You’ll no longer get a tax break
- Pro: You can extend your repayment term
- Con: You’ll lose access to repayment protections
How can you use home equity to pay for college?
Before we explore whether or not to use your home’s equity to pay for higher education, let’s address exactly how to do it.
There are three ways to borrow against your home equity:
- Home equity loan: Borrow a lump sum — typically around 85% of your home’s loan-to-value ratio — at a fixed interest rate.
- Home equity line of credit: Borrow as needed during a predetermined withdrawal period and repay at a variable or hybrid interest rate.
- Cash-out refinance: Refinance your mortgage for a larger amount, withdraw a cash portion of your equity, then repay the entire amount at a lower rate.
As you compare your borrowing options, let’s address the pros and cons they all share.
As a secured loan backed by your home, HELs pin more risk on the borrower, not the lender. Given that you’re assuming that risk, you’re more likely to be awarded a low interest rate.
Typically, HEL rates beat those of at least some federal student loans and, depending on your credit score, those of private loans and personal loans, too. Federal parent PLUS loans, which are borrowed and repaid under a parent’s name, for example, carry 7.08% fixed rates for the 2019-2020 school year. Meanwhile, the average fixed rate for a 15-year HEL, meanwhile, stands at 5.76%, according to ValuePenguin.
HELOCs almost always feature adjustable or hybrid rates that may begin as fixed before transitioning to variable. Variable rates could rise during your repayment, causing noticeable changes in your monthly payment amounts.
If your repayment goes awry on a federal or private student loan, your credit report could suffer. With every delinquency or, worse, default, your credit score would almost certainly fall.
Struggling in HEL repayment, meanwhile, would not only harm your credit — in a doomsday scenario, it could even cause a home foreclosure. Since a HEL is a secured loan, you risk losing your home, whereas student loans are not backed by equivalent collateral.
Even if you don’t lose your home, your property could lose value over time. There’s also the possibility that you could end up upside-down on your debt, meaning that you owe more to the bank than what the house is currently worth.
Opting for a HEL over a student loan puts more power in your hands as the borrower. For one, you could borrow significantly more.
Discover Student Loans, for example, lets you borrow up to 100% of your school-certified cost of attendance (including tuition, housing, books and more) minus other financial aid. Aggregate loan limits apply. The U.S. Department of Education, however, limits parents to borrow up to the school’s certified cost of attendance in PLUS loans, and only for eligible schools.
If you or your child need to borrow more than a lender will allow — perhaps for living expenses — or to attend a school ineligible for federal aid, a HEL could prove more useful than student loans.
Thanks to the Tax Cuts and Jobs Act of 2017, only interest paid on HELs used to buy, build or renovate a home — not for educational expenses — are eligible for tax deductions.
With federal and private student loans, however, you can still deduct interest paid toward your debt. You could lower your taxable income by as much as $2,500, depending on your income, and potentially drop into a lower income tax bracket as a result.
You could choose a home equity loan term similar to the 10-year standard federal student loan repayment term. HELs can also be extended to 15 years, making your monthly payment more affordable — which will also cost more in accrued interest over time. A HELOC, meanwhile, could give you 10 years to draw on your line of credit and 10 years to repay the balance for a combined 20-year term.
The flexibility of longer repayment terms on HELs is a benefit, but student loans also come with extended repayment term options. Federal loans, for example, can be prolonged to mortgage-like terms of 20 to 25 years using income-driven repayment.
Choosing a HEL over a student loan means you’re yielding valuable repayment protections.
You won’t be able to take a break from your HEL repayment the way you could via deferment or forbearance on a federal student loan.
Also, there aren’t any pathways to debt forgiveness for HELs. Such programs for federal student loans, including Public Service Loan Forgiveness, are sometimes difficult to qualify for, but they can lead to significant savings.
Consider all your college financing options
You should never feel backed into a corner when it comes to borrowing. Feeling behind on college savings might push you to consider borrowing against your home equity to pay for college. But before you choose a HEL or HELOC — or consider a similar cash-out refinance — exhaust the cheaper, safer options available to you. You could start by checking off these options one at a time via our checklist for parents seeking financial aid.