Should you use home equity instead of student and parent loans?
When deciding between utilizing a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance versus borrowing a student or parent loan, or refinancing an existing one, several trade-offs must be considered. Despite the popular notion of borrowers tapping into their home equity, these options essentially involve substituting one form of debt for another. It is crucial to weigh the advantages and disadvantages of each approach.
Advantages of Home Equity Loans and HELOCs
Home equity loans, HELOCs, and cash-out refinances present several benefits over student and parent loans.
Lower Interest Rates: Home equity loans and HELOCs may offer lower interest rates compared to Federal PLUS loans and private student/parent loans, due to being secured by the borrower's home. This reduced risk to the lender can result in savings of thousands of dollars in interest over the loan's lifespan for the borrower.
Interest-Only Payments (for HELOCs): Some HELOCs offer an initial 10-year period of interest-only payments, followed by fully amortized payments for the remaining five years. While this results in lower initial monthly payments, they significantly increase after the first decade.
Disadvantages of Home Equity Loans and HELOCs
Compared to student and parent loans, home equity loans, HELOCs, and cash-out refinances have several drawbacks.
Consequences of Default: Defaulting on a home equity loan, HELOC, or cash-out refinance can lead to the loss of the borrower's home. In contrast, defaulting on a student loan does not result in the repossession of education.
Fixed vs. Variable Interest Rates: Home equity loans typically have fixed interest rates, while HELOCs usually have variable rates. Federal loans have fixed rates, and private loans may offer both fixed and variable options. In a rising interest rate environment, variable rates can increase monthly payments.
Prepayment Penalties: Home equity loans and HELOCs may include prepayment penalties, unlike federal and private student loans.
Impact on Aid Eligibility: The remaining loan proceeds from a home equity loan must be reported as an asset on the Free Application for Federal Student Aid (FAFSA), potentially reducing the student's eligibility for need-based financial aid.
Limited Repayment Options: Home equity loans and HELOCs do not qualify for deferments, forbearances, income-driven repayment plans, death and disability discharges, or student loan forgiveness. They must be repaid upon selling the home.
Closing Costs: The closing costs associated with home equity loans and HELOCs can increase the overall cost of the loan.
It's essential to carefully evaluate these factors when considering whether to tap into your home equity for educational financing or refinancing purposes.
What type of debt is a student loan considered?
Type of loan: Student loans are unsecured installment debts, but the payment terms are more flexible than other loans. Interest rates: Interest rates on student loans vary.
Does student loan count as debt?
However, unlike other forms of debt – such as other types of loan, credit card debt, being in your overdraft, car finance payments, and so on – student loans DON'T normally appear on your credit file. This is important.
Do student loans count against debt to income?
When calculating your debt-to-income (DTI) ratio, your student loans will be factored in just as any other financial obligations. This ratio assesses your gross monthly income against your monthly debts and serves as a crucial benchmark for VA lenders.
Do student loans count against your credit?
A student loan will influence your credit score. The amount you borrowed and your payment history related to the loan are integral parts of your credit report. Specifically, your credit reports, which ultimately affect your credit score, will encompass details about your student loans, such as the outstanding balance you owe.
HELOC vs. Student Loan: Which Should You Use to Pay for College?
Financing a college education poses a intricate challenge for numerous households. More than 40% of them resort to borrowed money, and a staggering 70% indicate that they have altered their lifestyles to save extra funds for higher education.
Irrespective of your financial standing, adopting an innovative strategy can alleviate the burden of expensive tuition fees. It's likely that you've already considered federal student aid and private loans – but are you aware that you can leverage your home equity through a Home Equity Line of Credit (HELOC) to fund your child's education? When comparing HELOCs to student loans, there exist notable differences and drawbacks. Which option aligns better with your family's financial aspirations? Let's delve into it.
What constitutes a HELOC?
A HELOC is a secondary mortgage that enables homeowners to obtain cash by borrowing against the equity in their home. Being secured by the equity of your residence, a HELOC serves as a collateralized loan.
Broadly, there are two primary types of HELOCs: Variable-rate HELOCs, where interest rates fluctuate in tandem with national interest rates, and fixed-rate HELOCs, which have interest rates predetermined at the loan's inception and remain constant throughout.
How does a HELOC operate?
Unlike other loan types (including home equity loans) that provide borrowers with a one-time lump sum, HELOCs operate akin to credit cards. A HELOC functions as a revolving line of credit, allowing you to utilize only the funds you require, when you need them. Similar to a credit card, interest is only charged on the amount you utilize.
HELOCs encompass two distinct phases. The initial phase is the draw period, during which you can withdraw funds from the line of credit while making only interest payments.
The subsequent phase is the repayment period. In this stage, you commence repaying the principal amount borrowed along with interest, mirroring the repayment structure of an amortized loan. At this juncture, you cannot continue withdrawing from your line of credit. Your borrowing capacity ceases once the draw period concludes.
The duration of the draw period varies but typically ranges between five and ten years. However, some draw periods can extend up to fifteen years, contingent on the lender. The repayment period is generally longer. While the precise length depends on the terms of your HELOC, typically, the repayment period spans between ten and twenty years.
How much can I borrow?
The amount you can borrow varies based on your home's value and the equity you hold in it – indicating how much of your mortgage you've repaid. To qualify for a HELOC, you must meet certain criteria.
You must possess a favorable debt-to-income ratio.
You should have a strong credit score.
The value of your home must exceed the amount you owe on your mortgage.
Utilize a HELOC calculator to estimate your borrowing capacity and the cost of your monthly payments. Typically, homeowners can borrow between 85% to 90% of their home's value after deducting their outstanding mortgage balance.
Can a HELOC be used to pay for college?
Yes, you can utilize a HELOC to finance college education. HELOCs provide borrowers with access to cash, which can be used for various purposes, from funding education to making home improvements. While most homeowners use HELOCs to invest in their homes, it's perfectly acceptable to tap into your home's value to cover tuition, textbooks, housing expenses, or any other college-related costs.
Advantages and disadvantages of using a HELOC for college expenses
For some families, a HELOC could be the ideal solution to liberate cash for college expenses while steering clear of student loan debt. For others, staking the family home on a child's college education might feel overly risky – especially for parents who are uncertain about footing the tuition bills. Here are some considerations to keep in mind when exploring a HELOC for college funding.