Your home’s equity can be used not only for home improvements but also for paying off your 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.
Secured vs. Unsecured Loan
Student loans are 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. 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 since there isn’t any collateral, you’ll probably 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.
Types Of HELOCs
Depending on how your mortgage was opened, you may already have a HELOC. Check with your mortgage company. If you don’t have a HELOC, you’ll need to apply for one.
If you are applying for a HELOC with the same company who has your mortgage, the application process should not be too involved. You can also try for a lower rate HELOC using a different company, which may require more paperwork.
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.
Fixed rate is a sure thing. With a variable rate, you don’t know what might happen.
There is also a hybrid version that allows you to convert from variable to fixed rate. You can lock in a fixed rate for some predetermined number of years. This may or may not be advantageous.
If rates are low, a variable rate HELOC is likely lower than a fixed rate HELOC. But once rates start rising, variable rate HELOCs will rise with them, eventually surpassing a fixed rate HELOC.
Since most students are fixed rate, going with a fixed rate HELOC is the best option.
The Right Time To Use Your Home's Equity
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 probably 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 here and here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards 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, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.