Can I Use Home Equity to Pay Off Student LoansNovember 13, 2020
It feels great when the work you’ve put in pays off in multiple ways. Whether it’s seeing your blood pressure drop from biking to work or getting a boost to your mood from toiling in the garden, unexpected benefits are always a welcome surprise.
So if you’re paying off student loans and a mortgage at the same time, you’ll probably be interested to hear that you can use the home equity you’ve already accrued to pay off your student loans even faster.
That might sound enticing, but don’t start drawing up the paperwork just yet – this strategy doesn’t work for everyone. Here’s how to use a home equity loan to pay off your student loans, and why you might want to think twice before doing so.
How a Home Equity Loan Works
Borrowers with high interest rates on their student loans can take out a home equity loan and use the proceeds to pay off their student loan balance. A home equity loan lets homeowners withdraw extra equity from their homes to use for any reason, like remodeling the kitchen or paying for a vacation.
The money is deposited as a lump sum, and borrowers start making payments on the new loan immediately. Home equity loans usually have fixed monthly payments, and the terms range from five to 15 years.
Homeowners need at least 20% equity in the home to take out a home equity loan. This often excludes new borrowers who don’t have enough equity yet.
Pros of Using Home Equity to Pay Off Student Loans
Here’s how a home equity loan could help you save money:
Could Save on Interest
Interest rates on home equity loans are usually lower than private student loans, which means borrowers can save thousands on interest. As of November 2020, rates on private student loans ranged from 3.82% to 14.50%. Rates on home equity loans are currently between 3.890% and 9%.
Let’s say you owe $50,000 in student loans with a 10% interest rate and a 10-year term. If you take out a home equity loan for $50,000 with 5% interest and a 15-year term, you’ll save $8,118 in total on interest. Your payments will decrease from $660.75 to $395.40 a month.
Could Decrease Your Monthly Payments
If you want more leeway in your budget, paying off your student loan payments with a home equity loan could free up the cash you need.
For example, if you have five years left on your student loans and take out a 15-year home equity loan, your monthly payments will decrease.
If you owe $40,000 in student loans with 10% interest and five years left, you’ll pay $534 less each month if you get a home equity loan at 5% interest and a 15-year term. You can use that extra cash flow to build up your emergency fund, save toward retirement or spend on other necessities.
Easier to Qualify for a Home Equity Loan
A home equity loan is easier to be approved for than student loan refinancing because it uses the home as collateral. On the flip side, that means you’ll need to stay current on both your mortgage and home equity loan in order to avoid losing your home.
Cons of Using Home Equity to Pay Off Student Loans
Taking out a home equity loan to pay off your student loans sounds like a no-brainer, but there are some huge risks.
Can’t Deduct the Interest
Before the Tax Cuts and Jobs Act of 2017, homeowners who took out home equity loans could deduct the interest on their taxes. The TCJA changed the rules so only homeowners who use the funds to repair, remodel or add to their homes can deduct the home equity loan interest.
This means there are no tax benefits to taking out a home equity loan to pay off your student loans. However, borrowers may be able to deduct student loan interest on their taxes.
Married couples can only take the student loan interest deduction if they file taxes jointly and have a modified adjusted gross income (MAGI) below $140,000. Individuals may be able to deduct student loan interest if their MAGI is below $70,000. Please note, you should consult a tax advisor about your specific circumstances.
Risk of Losing Your Home
When you take out a home equity loan, the home is used as collateral for the loan. If you default on a home equity loan, the bank can repossess your house.
The risks are much lower for student loans. If you default on student loans, the lender can’t take away your property or rescind your degree.
Lose Student Loan Benefits
If you pay off federal student loans with a home equity loan, you lose access to federal benefits and protections. These include income-driven repayment plans, deferment and forbearance.
Could Become Underwater on Your Home
If home prices in your area drop significantly, you could end up underwater on your mortgage. This means that your home will be worth less than the remaining loan balance.
Being underwater makes it impossible to refinance your mortgage or sell the house, because the sale price won’t make up for the loan balance.
Will Have to Pay Closing Costs
You’ll have to pay closing costs on a home equity loan, usually between 2 to 5% of the loan. In this way, a home equity loan is similar to a mortgage refinance.
If your home equity loan is $25,000, for instance, you’ll pay between $500 and $1,250 in closing costs. Sometimes you can roll these closing costs into the mortgage, but you’ll often have to pay them upfront. Lenders don’t charge closing costs on student loan refinances.
What to Do Instead
Instead of taking out a home equity loan, you may be better off refinancing your student loans to a lower interest rate. Refinancing student loans lets you save on interest without putting your home down as collateral.
To see if you qualify for student loan refinancing, contact an ELFI representative today. They can go over the steps and see if you qualify.
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The information contained in this blog is intended for educational and informational purposes only and should not be construed as legal, financial or tax advice.