When it comes to student debt payoff, it pays to get creative. From forgiveness programs, to employer student loan repayment, to student loan refinancing, there are lots of ways to reduce the overall cost of student loan repayment.
But would it be worth your while to pay off your student loans with a personal line of credit instead of student loan refinancing? That would certainly be an "out of the box" move. Yet some borrowers may feel like it could save them money while also providing a higher level of payment flexibility.
When it comes to a personal line of credit vs. student loan refinancing, which is best? This article explains why private student loans will generally be superior to a personal line of credit for lowering your student loan interest rate.
What Is A Personal Line Of Credit?
A personal line of credit is considered revolving credit. It is a type of debt that closely resembles a credit card or a home equity line of credit (HELOC). When borrowers take out a personal line of credit, they can borrow up to a set limit (say $30,000). Borrowers only pay interest on the amount they draw against the line of credit. You can typically use a personal line of credit to pay for anything you want.
For example, a borrower who uses $10,000 on the line of credit will pay interest only on the $10,000 borrowed. They will not pay interest on the full $30,000 line of credit. As borrowers repay the line of credit, the remaining credit limit goes back up.
The interest rate on personal lines of credit are similar to the rates on personal loans. Some people will qualify for excellent rates. But most times the interest rates will be in the double digits. Many times, the interest rate on a personal line of credit is considered variable. That means the rate can change based on fluctuations in the market.
What Is Student Loan Refinancing?
Student loan refinancing involves taking out a private student loan to pay off another student loan. A private student loan is still an educational loan and it is usually an installment loan.
With installment loans, borrowers who make payments as agreed will repay the student loans in a fixed period of time. The monthly payment and the interest rate on the loan are often fixed for the life of the loan.
Personal Line Of Credit Vs. Student Loan Refinancing
A personal line of credit and a private student loan are both private debt. Both are used to pay for education. However, the loan options have distinct differences related to uses, repayment, taxes, credit scores and bankruptcy.
Uses
A personal line of credit can be used for almost anything. You may be able to use the line of credit to pay for upgrades to your house, pay off credit card debt, and potentially pay off some or all of your student loans.
However, a bank may not allow borrowers to use it to repay student loans. Limitations on uses will vary from bank to bank.
For example, First Republic Bank offers a Personal Line of Credit, and they mention it can be used for student loans along with other things.
By contrast, private student loans can only be used to pay off existing student loans. You cannot roll other debts into a student loan refinance.
Repayment
Private student loans are almost always installment loans with fixed interest rates. That means, your loan payment will be the same month in and month out for a fixed period of time. After that time, your loan will be paid off.
By contrast, a personal line of credit is a form of revolving credit. The interest rate is likely to change over time. And the minimum payment may not lead to payoff during an initial lending phase. Borrowers who are hoping to get rid of student loan debt should consider paying more than the minimum to reduce interest costs.
Tax Implications
As you're comparing a personal line of credit vs. student loan refinancing you'll want to consider which type of debt would save you the most on your tax bill.
Student loan borrowers are entitled to student loan interest deductions up to $2,500 per year. This tax benefit is a great way to save up to a few hundred dollars each year. However, the benefit is only for qualified student loans.
Qualified student loans are loans that are used exclusively to pay for educational expenses. The loans must be:
- For the taxpayer, spouse or dependent who was a student.
- For education provided during an academic period when the student was eligible.
- Educational expenses had to be paid within a reasonable period of time before or after you took out the loan.
Private student loans almost always meet this requirement. Student loans are only issued for the cost of attendance associated with an eligible student’s time in school.
Theoretically, a personal line of credit could qualify as an educational loan. However, a borrower may have a tough time proving that all three of these qualifications were met at the time of borrowing.
And, if you use the personal line of credit to pay for other expenses, it definitely doesn’t qualify.
Credit Score Implications
When you run up a personal line of credit, you are increasing your credit utilization ratio. And just like running up a credit card bill, that can hurt your credit score.
In general, you want to keep credit utilization low on all your revolving lines of credit. Thankfully, your credit score will only increase as you pay the line of credit down.
By contrast, student loans are installment loans. As long as you pay down the loans as agreed, the effect on your credit score will be neutral or positive.
Bankruptcy Implications
Technically, student loans are dischargeable in bankruptcy. But the borrower must demonstrate that they are facing undue hardship, which can be difficult (but not impossible) to prove in a court of law.
By contrast, a personal line of credit can often be discharged in bankruptcy. However, a bankruptcy judge may require a borrower to repay the line of credit if it is deemed to be an educational loan. That means you shouldn’t try to do a last-second loan refinancing before filing for bankruptcy in an effort to get your loans discharged.
Which Type Of Financing Should You Choose?
In general, borrowers should avoid using a personal line of credit to pay off student loans. While it may offer a small interest rate arbitrage opportunity, the tax and credit score implications are likely to outweigh the benefits.
So does that make student loan refinancing the right choice for most people? Not so fast. While this article assumes that a borrower wants to refinance, that may not actually be the best option for federal student loan borrowers. When you refinance federal student loans, you lose access to things like Income-Driven Repayment (IDR) plans, forgiveness programs, and other federal benefits.
If you have federal student loans, you'll want to be careful when considering any refinancing strategy. Learn how to decide if student loan refinancing is right for you.
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 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.