David McMillin | Bankrate.com (TNS)
If you’re gearing up to send a child to college, the cost can feel overwhelming. A home equity line of credit (HELOC) or home equity loan could help pay for it — but before leveraging your home ownership stake in this way, you’ll need to balance a number of considerations. Here’s our crash course on the pros and cons of using your home to pay college tuition or other educational bills.
Homeowners can tap their equity and use it for a variety of big expenses, including major home improvement projects, large medical bills, debt consolidation — and yes, higher education costs.
Home equity represents the portion of your home that you own outright — equivalent to the initial down payment, plus any mortgage payments made since then. Another way to look at it: Home equity is the difference between what your home is worth and what you still owe on your mortgage.
Your home equity isn’t just a theoretical amount, though. It can be turned into cash (as the ads say) — or, strictly speaking, as collateral for a cash loan. You can borrow against your home equity in two basic ways: home equity loans and HELOCs.
A home equity loan is a type of second mortgage that provides a lump sum at a fixed rate. A home equity line of credit (HELOC) is also a second mortgage, but it operates more like a credit card. You access the money as needed, instead of receiving one large loan, paying variable interest rates on the amount you borrow.
For example, if you were to have $170,000 remaining to pay off on your mortgage and your home was worth $400,000, you’d have $230,000 in home equity. Since lenders typically require you to maintain some equity in your home, and that your overall debt be well below the home’s worth, you could probably take out around $150,000 of this ownership stake. This could go a long way towards college funding.
Advantages of using home equity loan to pay for college
—Potentially cheaper: Home equity loans and HELOCs typically offer lower interest rates than personal or private student loans, because your home is backing the debt.
—Large borrowing capacity: Depending on your home’s equity, you often can access a larger sum of money, especially compared to federal student loans.
—Pay as you go: With HELOCs, you can withdraw funds as you need them, only paying interest on the actual withdrawals. You can also repay the principal in stages, rather than having a mountain of debt after graduation day.
—No debt for your child: Using a home equity loan to pay for college means your child can start their post-graduation life without the burden of student loan debt, improving their financial outlook from the outset.
Drawbacks to using home equity loan to pay for college
—You’re adding to your debt: Taking on more debt can strain your finances and add to your stress. You need to make sure you’re comfortable sleeping at night knowing your monthly obligations are getting bigger. HELOCs’ variable interest rates can mean increases in monthly payments, too.
—You’re putting your home at risk: Unlike credit card debt or personal loans, when you take out a home equity loan, your property is on the line as collateral. If you fall on hard times and can’t afford to make your payments, your lender could foreclose.
—Your property value could decrease: Your home depreciating might seem unlikely right now, but prices don’t always follow the rapid upward trajectory we’ve seen in recent years. Indeed, some local real estate markets have experienced softening already. If your home value drops significantly, you could find yourself underwater — that is, owing more than it’s worth.
Home equity loans vs. student loans to pay for college
While you can access your home’s equity for any purpose, student loans are solely for covering the costs related to earning a degree. They are unsecured loans — that is, there is no collateral backing them.
Student loans can come from either federal or private sources. On the private lending side, rates can be very high (or fluctuating), while federal lending programs offer lower fixed rates. Private student loans are issued by banks or companies like Sallie Mae. They require credit checks and some lenders require a cosigner.
In contrast, HELOCs and home equity loans are secured loans issued by private lenders. Using a home equity loan to pay off student loans or fund education directly places the financial responsibility on the parents, as they own the home that’s backing the debt. In contrast, student loans can be taken out in either the student’s or the parent’s name.
There are benefits and drawbacks to both.
Student loan pros:
—Rates may be lower than home equity loans and HELOCs.
—There is the potential for the loan to be forgiven for certain borrowers.
—You may deduct up to $2,500 of interest each year.
Student loan cons:
—Private student loans have potentially excessive interest rates.
—These loans often saddle your child with a big debt load.
—Income-based repayment option only available to certain borrowers.
HELOCs/home equity loan pros:
—Debt is on the parent, not the child.
—The borrower can choose from a range of repayment options.
—You can borrow funds as you need them, owing interest only on what you use (HELOC).
HELOCs/home equity loan cons:
—Your house is the collateral.
—Interest not tax-deductible if the loan is used to pay for college.
—The loan size limited by the amount of tappable equity.
Alternatives to using home equity for college
If tapping your home equity doesn’t feel like the right choice, consider these other routes to come up with the necessary funds. These options can also complement student or parent loans. Make sure to explore all options thoroughly before using home equity, as inability to make payments might cause the lender to foreclose on your home.
—Grants and scholarships: Don’t assume that grants and scholarship opportunities are only for low-income students. Many universities offer merit-based scholarships that reward academic performance, and there are other places to turn for financial assistance, as well. Some scholarships are small — just $500 — but they can add up to cover the entire bill.
—Financial aid: Make sure you complete the FAFSA (Free Application for Federal Student Aid) application, which can help your student qualify for monetary assistance based on your income. Again, don’t assume aid is only for those with extremely low incomes. This form is important for loans as well (see below).
—Work-study programs: Monitor the computer lab, grade papers, lead campus tours: Many colleges offer work-study positions for students who qualify for financial assistance. Students will earn at least the federal minimum wage (and much more in some cases).
—College payment plans: Many financial institutions now offer their own monthly payment plans, which might be easier to manage than handing over a large check at the beginning of the semester — and a better deal than home equity loan repayments.
—529 plans: A 529 plan is a tax-advantaged savings account designed specifically for education expenses. You contribute after-tax money to the account, which grows tax-deferred, and you can withdraw the funds tax-free to pay for qualified education costs like tuition and books. Some states also allow you to deduct your contributions to the plan.
Considerations for using home equity to pay for college
There’s no one-size-fits-all answer regarding whether tapping home equity is the right choice to cover college costs. Ask yourself these key questions to determine if it’s the best option for you and yours:
What are your student loan options?
If you’re going to borrow, you have to compare home equity financing with student loan financing. Be sure to check out options for federal student loans (the traditional go-to) and private student loans. Bear in mind students rarely have much credit, so if your child is borrowing without you as a co-signer, their rate can be high, and paying off the debt can be daunting.
Consider these parent loan options to fund your child’s college education:
—Parent PLUS Loans: Part of the federal government’s Direct Loan Program, these loans are taken out by parents, to pay for a dependent undergraduate’s academic or vocational school. Parents need to have a good credit history to qualify for these loans. The interest rate for a Direct PLUS Loan disbursed between July 1, 2024 and July 1, 2025 is fixed at 9.08% for the entire term — a tad higher than the current 8.52% home equity loan average. Parent PLUS loans come with a loan fee of 4.228%, a one-time fee deducted from the initial disbursement of funds.
—FAFSA Application: Parents can complete the Free Application for Federal Student Aid (FAFSA) to determine their child’s eligibility for government student loans.
—Private Parent Loans: For people with poor credit, this is a feasible option, although it comes with higher interest rates and no federal loan protections.
What are current home equity rates?
While rates on home equity loans and HELOCs have historically been competitive with other financing, they rose fast in 2023, as the Federal Reserve has upped the federal funds rate to fight inflation. While they’ve stabilized this year, and are projected to decline further in 2024, they can no longer be considered cheap. So crunch the numbers carefully: For a similar financing cost, it might make more sense to go with a student loan at this time, depending on the deal you or your child can get.
What does your future look like?
If you will have more than one child in college simultaneously, a home equity loan might not provide enough money to handle both sets of tuition, room and board, unless you own a high-priced home and have a significant amount of equity built up.
You also need to think about the big picture, and your long-term lifestyle plans. When do you plan to retire? A big additional debt could affect your ability to save for those post-work years. Do you intend to unload the old homestead once the fledglings leave the nest? Like a mortgage, a home equity loan has to be paid in full when you sell. That’ll cut into the proceeds, which could cause a financial strain, even if you’re downsizing.
What does your student’s future look like?
It might be too early to know, but if your child has a set career path already, they might be eligible for student loan forgiveness in the future. Teachers, government employees and employees at some non-profit organizations can eventually have a portion of remaining debt canceled after a certain point. In contrast, with a home equity loan, you’ll need to pay every dollar back.
How to tap home equity to pay for college
If you feel like tapping your home equity is the right decision, here’s how to get started:
—Estimate your equity. Your home’s value is not the number you initially paid for it. Home prices tend to appreciate, and they have done so at a frenetic pace over the past two years. Estimate what your house is worth to get a sense of how much equity you really have to tap. Bear in mind that a large outstanding mortgage balance eats into your available equity.
—Know your credit score (and take steps to improve it if necessary). While you can get a home equity loan with bad credit, you won’t qualify for the lowest interest rates. Most lenders reserve the best loan terms for borrowers with scores of 740 and above. Check your credit score before you apply, and see if you can boost it.
—Compare lenders. Consider at least three home equity lenders and compare rates, fees, term lengths, maximum loan amounts, credit requirements and more. Consider other features you might need down the line, as well, such as the ability to convert a variable-rate HELOC to a fixed-rate version.
—Decide which financing method you prefer. HELOCs and home equity loans each have their pros and cons. In the case of college funding, HELOCs might have an edge, as they’re well-suited to expenses that extend over a long time period: You can withdraw money in installments — per year or per semester — only owing interest on the amount you actually borrow.
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