Why Tapping Home Equity to Repay Student Loans Is Always a Bad Idea

using-home-equity-to-pay-off-debt

Did you buy your home at a fantastic deal during the recession? Has it climbed in value since?

If so, you most likely have a good deal of equity in your home. This presents an opportunity: you can “cash out” by refinancing your mortgage or opening a home equity loan at low interest rate.

So should you tap into that equity to repay your pesky student loan debt?

Put bluntly, no.

The Problems of Using Home Equity to Pay Off Debt From College

Student loans and home equity do not mix. Let me repeat: using a home equity loan to pay off student debt is a terrible idea that could be detrimental to your finances and your family. As attractive as it seems on the surface, don’t put your financial security and your home on the line to pay off student loans. The financial risk isn’t worth it.

I know you’re probably thinking, “But why not? I could pay off all of my student loan debt and be free and clear. I’m already paying my mortgage anyway.” Let’s explore all the reasons why this is a bad idea:

You’re not actually paying off your loans.

You won’t actually pay off anything, you’re simply reshuffling your debt — your student loan debt will have essentially moved from one account to another. It’s not paid off, you still have the debt, and it’s now just under a new name. Instead of “student loan debt” it would now be “home equity loan debt.”

This new debt might have a lower interest rate (or not), depending on your student loan interest rates. But it also carries additional risks. And that leads to my next point…

You’re putting your home at risk.

Taking out that balance against your home’s value could put your family in jeopardy if financial emergencies arise. What will happen if you suddenly find yourself laid off from your job or facing enormous medical bills? What happens if you can no longer afford your equity loan payments?

If you turn your student loan debt into equity loan debt, and you aren’t able to make loan payments, you may lose your home to foreclosure..

In the best-case scenario, you’ll be able to “short sale” your home, which means you’ll fire-sale it for less than the amount you owe your lender. Even in this best-case scenario, but you’ll still lose your home.

Student loans are unsecured debts, meaning that they’re not guaranteed by any physical collateral like a car or house. If you default on your student loans, there’s a risk that your wages may be garnished or you’ll never see a tax refund. But your lender won’t go after your home.

If you transfer an unsecured debt (student loans) to a secured debt (a refinanced mortgage or home equity loan), your house is suddenly up-for-grabs.

You could end up with a higher interest rate than you started.

If you don’t fully understand the terms and conditions behind your home equity loan, you may unknowingly be shifting your debt into an account that could have an even higher interest rate than your student loan debt after the introductory period has ended.

Not all home equity loans have fixed interest rates and you could be setting yourself up for interest rate whiplash if you don’t pay attention to the fine print.

You won’t be eligible for student loan forgiveness programs.

If you make your student loan payments consistently, you may be eligible for a student loan debt forgiveness or cancellation program. Transforming your student debt into a home equity loan will immediately disqualify you for any sort of federal program to help pay it off. If you want to keep your options open for debt forgiveness or cancellation programs, never transfer your loans to a private loan, consolidate them with other debt, or trade it for a home-equity loan.

Expert Advice On Using Home Equity to Pay Off Student Loans

Financial guru Dave Ramsey considers home equity loans to be a con. In an interview with Bankrate, he stated paying off any other loan by transferring into a home equity loan is one of the biggest financial mistakes that people make.

Your home and your equity are your biggest financial assets, he explained. If you tap into that equity to pay off debt of any kind — whether its student loan debt, credit cards, or for debt consolidation — you’re essentially turning your biggest financial asset into your biggest liability.

What should you do?

If you shouldn’t take out a home equity loan, than what should you do to pay down your student debt? Here are a few tips:

1. Trim your expenses. Cut your spending as much as possible, rebuild your budget with the new numbers, and apply your savings to your highest interest-bearing student loan amount. Once that loan is paid off, continue paying that same amount towards the next balance, and so forth, until your loans are gone for good.

2. Start a side gig. Try working a part-time job from home or on the weekends by developing a “side hustle,” and use this extra income to more aggressively repay your student debts.

3. Create a plan. Develop a solid roadmap that will allow you to abolish your student loans for good – rather than just transferring them into a new name.

Don’t put your home on the line to just reshuffle your debt. It’s not worth it.

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