When it comes to paying for college, some parents look for alternatives like using a HELOC or home equity loan instead of student loans.
Your home’s equity can be used not only for home improvements but also for paying for college, or even paying off old student loans.
When it comes to using your home’s equity, Helen Huang, Senior Director of Product Marketing for SoFi’s mortgage products, says there are plenty of benefits, “Equity is a tool for improving your financial position. Use it to pay off higher interest credit cards or student debt, or to make high-value improvements to your home—like remodeling a kitchen. Banks need to know you can use the equity responsibly.”
To utilize your home’s equity, your bank or mortgage company creates a HELOC or home equity line of credit. You can take draws on this line up to the limit. Once the line has been created, you can continue drawing on it without the need to fill out an application each time.
Rick Huard, a TD Bank senior vice president of consumer products, notes, “A HELOC is typically a 20- or 30-year term.
A lot of things might change over that time. This allows the customer — without having to spend more money for closing costs or fees or going through an application process — to continue to meet their borrowing needs over the entire life of their relationship with us.”
In this article, we’ll look at using a HELOC to pay down student loans, along with a few financial factors to consider.
What Is A HELOC Or Home Equity Loan?
A HELOC is a Home Equity Line of Credit. This is a loan that you take out against the value of your house, and you can tap into it during the draw period. You typically pay interest-only during the draw period, and then you full pay back the loan during the repayment period.
A Home Equity Loan is similar to a HELOC, but there's no draw period. You just take out one lump sum of money against your home equity.
What does this look like in practice? If you own a home worth $800,000, and have a mortgage of $400,000, you have $400,000 of "home equity". These loans allow you to tap into that money - usually up to 75% or 80% of your home's value. In this scenario, an 80% HELOC or Home Equity Loans means you could borrow $240,000.
Remember, just like a mortgage, if you don't pay back your HELOC or Home Equity Loan, you could face foreclosure. There are HELOC alternatives now that allow you to tap your equity in exchange for equity. This is a nice alternative since you won't have to make monthly payments.
HELOC vs. Home Equity Loan vs. Equity Sharing
HELOCs come in a few forms - fixed and variable interest rates and a hybrid. Variable rate HELOCs are the most common. They are tied to the prime rate plus an additional amount. They can go up or down.
A fixed rate mortgage doesn’t adjust and instead has a fixed rate. A fixed rate HELOCs can be higher than a variable rate HELOC. However, if the variable rate HELOC starts increasing, it can go higher than the fixed rate HELOC.
The nice thing about a HELOC is that you can take out the amount you need, without seeing your loan repayment rise. So, if you only need $10,000 this year, that's all you have to draw.
The home equity loan is nice because it's fixed, but you have to take it as one lump sum. So, you have to borrow the full $240,000, and begin payments on that amount - even if you only needed $10,000 in the first year to pay for college.
You can shop for a HELOC or Home Equity Loan at normal mortgage lenders, your bank, or credit union. Make sure you get 3 quotes.
The home equity sharing agreements are very much like a home equity loan, but there are NO monthly payments. This is nice because, while you get the lump sum up front, you don't have to begin making payments right away.
Check out Point, HomeTap, or Unlock for quotes on home equity sharing.
Secured vs. Unsecured Loan
Student loans are "semi" unsecured loans. This means you didn’t have to put up any collateral to back the loan. Instead, the loan is backed by the government, but also your future earnings. This is unlike another type of popular unsecured loan - credit cards. Credit cards are backed by nothing. Just your promise to pay them.
If you aren’t able to pay your student loan, you’ll end up having your wages garnished or tax refunds claimed by the government.
In contrast, a HELOC is backed by your home. As is your mortgage. When paying off student loans using a HELOC, you really aren’t paying off the loan. You’re simply transferring it from one account to another.
It’s important to be aware that if something goes wrong and you can’t pay your HELOC, your home could be in jeopardy. In a worse case scenario, you could even lose it.
Assuming you can make on-time payments, if the HELOC has a much lower interest rate than your student loan, you can save a lot of interest. That’s one of the main advantages of using a HELOC for paying off student loans.
Keep in mind that by transferring your student loans to a HELOC, you’ll lose any advantages offered by student loan hardship programs.
In contrast, if you can't afford to pay back your student loans, you have a wide variety of income-driven repayment options, loan forgiveness options, and hardship options like forbearance and deferment. Basically, federal student loans are much more flexible than HELOCs.
Student Loan vs. HELOC To Pay For College
So, should you use a HELOC to pay for college or a student loan? Honestly, most families should consider student loans.
First, there's an order of operations to pay for college. You should always borrow federal student loans first, then look at private student loans.
Federal student loans have a LOT of benefits that make them better than HELOCs. They have income-driven repayment plans, the offer loan forgiveness programs, and they have a variety of deferment and hardship options. Also, their interest rates are very low - roughly 5.5% for undergraduates in 2024.
The big problem with Federal loans is that there are low loan borrowing limits. This is by design - to protect you from overborrowing for college. But the truth is, many families need more funds to pay for college.
So, what's next? A HELOC or private student loans? Again, private student loans are usually a better option than a HELOC.
Rates will likely be the same, or lower, than a HELOC for the same qualified borrower or cosigner. Private loans are unsecured, and while you as a cosigner may be liable, you aren't putting your home on the line for collateral (in most states).
Find The Best Student Loan Rates.
When comparing student loans and HELOCs, the number one focus should be the interest rate. Check out our list of lenders and get 3-5 quotes to shop around and find the lowest rate.
The Right Time To Use Your Home's Equity
It's never a good idea to use a HELOC or home equity to pay for college.
However, if you're already graduated and have PRIVATE student loans, it could make sense to use a HELOC or home equity loan to "refinance" that debt.
If you can secure a fixed HELOC that has a rate lower than your student loan, it is worth the consideration of using your HELOC to pay off the student loan. You’ll might save thousands in interest.
Moving a student loan to a HELOC does mean your home is at risk if you default on the HELOC.
You could also look at potentially selling your home's equity by using a service like Point.
But if your financial situation is robust enough that you can make your payments every month, the risk is greatly reduced.
Have you ever considered using a HELOC to pay off your student loans?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared toward anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications, including the New York Times, Wall Street Journal, Washington Post, ABC, NBC, Today, and more. He is also a regular contributor to Forbes.
Editor: Clint Proctor Reviewed by: Chris Muller