Student loans have become a common monthly expense for American homeowners. If you’re in this situation, you may have considered using your home equity as a means of repayment. You can even use a home equity loan for debt consolidation.
While a home equity loan will provide you with the funds to pay off your student loan debt, certain factors should be accounted for before signing any agreement. If the risks associated with home equity loans—most notably, using your house as collateral—seem too steep or don’t match your financial situation, evaluate the potential alternatives available.
So, can you pay off student loans with home equity? Yes.
However, a better question might be: Would a home equity loan be the right financial decision for paying off student loans? Let’s dive in and see if there’s a home equity alternative that’s better for paying off your loans.
Overall Student Loan Debt at a Glance
In 2020, total student loan debt amounted to $1.6 trillion across 44.7 million Americans. The full figure outsizes the outstanding debt for both credit cards and auto loans combined. Relying on 2020 Census data, 13.5% of the total U.S. population (regardless of age) manages an average of $35,794 in student loan debt on top of their other household expenses.
With the median U.S. per capita income calculated to $34,103, the average American wouldn’t be able to pay off the average in student loan debt even if they dedicated the entirety of their yearly gross income to doing so.
More than understandably, Americans seek solutions to minimize these ongoing education costs they’re stuck with long after completing the paid-for programs. Many homeowners have turned to home equity loans as one solution since the Tax Reform Act of 1986 allowed them to claim deductions on paid interest.
But is this the right choice for you?
What Is Home Equity, and How Do You Use It?
Home equity refers to the house value owned by homeowners, which accrues over time due to making mortgage debt payments. To calculate your home equity, determine the property’s market value and subtract your remaining mortgage loan balance from it. If you were to sell your home right this minute, your home equity represents the amount that goes to your wallet.
If your home currently holds a value of $300,000 with a remaining mortgage loan balance of $200,000, you’ve accrued $100,000 in home equity between your down and ongoing mortgage monthly payment.
The primary hurdle with home equity is that the value remains inaccessible until you sell your home. Unlike the cash in your bank account that can be used via debit cards or accessed with a trip to the nearest ATM (i.e., “liquid” assets), you can’t simply pull funds from your home equity as needed or to pay down student loans (i.e., “nonliquid” assets).
To do so, some homeowners sign for a home equity loan, which is the process of using HELOC to pay off a mortgage or settle debts.
The Primary Risk of Home Equity Loans for Your Student Loans
The risks associated with using a home equity loan to pay off student debt relate to the fact that homeowners must still borrow money to access their owned portion of their property’s value.
Your House as Collateral
Lenders regard home equity loans as a “secured debt.” This label refers to the collateral that loan recipients provide as a guarantee of repayment. With home equity loans, your house serves as the collateral.
Homeowners must still repay the dispersed funds—typically restricted to 85% of equity—according to their signed agreement (e.g., fixed rate and monthly payment amounts). If loan recipients don’t adhere to the repayment agreement, the lender can seize the home listed as collateral.
Since the loan relies on your home equity to secure it, that portion of your total assets becomes “spoken for.” Some portion of the value you’ve accrued by paying down your mortgage debt converts to the disbursed funds and an equivalent amount of debt. As such, home equity loans are commonly referred to as “second mortgages.”
Home Equity Loan Repayment Terms
Generally, borrowers repay home equity loans over 15 years. The loan agreement signed following a homeowner’s approval will specify the loan’s term and monthly repayment amounts. As lenders disburse home equity loan funds as a “lump sum,” all parties to the agreement know the total amount from the outset, along with the fixed interest rate, terms, conditions, and any fees.
Using HELOC for Student Loans
In contrast to the “lump sum” disbursement received following home equity loan approval, a HELOC (i.e., “home equity line of credit”) provides homeowners with a credit limit against which they can borrow funds over time. HELOCs operate somewhat similarly to credit cards, with the limits determined by your home equity rather than a more arbitrary number set according to your credit score and other financial factors.
Homeowners who receive home equity line of credit or HELOC approval may draw funds against their home equity over a set period, typically ten years. Like a credit card, borrowers may draw funds to make payments on student loans, repay the amount, and draw again as many times as needed during the initial period. Once the withdrawal period ends, homeowners may not borrow any more while still repaying any outstanding debts. This repayment period typically lasts ten to twenty years.
Another significant difference between home equity loans vs. HELOCs is that the former establishes a fixed interest rate for the loan’s duration. In contrast, borrowed amounts are subject to variable rates with HELOCs.
Who Qualifies for Using Home Equity Loans to Repay Student Loans?
Though any homeowner looking to eliminate education debt may apply, not everyone qualifies for home equity loan approval. Lenders require applicants to meet strict financial requirements before approving the loan.
To qualify for a home equity loan to use when paying off your private student loan (or other debts and expenses), most homeowners must meet the following conditions:
- A credit score of 650 or higher
- A minimum home equity of 15-20%, as compared to the property’s overall value
- A low debt-to-income ratio
- Demonstration of financial means and responsibility (e.g., prior years’ taxes, recent paycheck stubs, bank account balances)
Paying Off Student Loans with Home Equity
When home equity presents itself as an option for paying off other debts, it can be difficult not to jump at the chance immediately. Unfortunately, while home equity loans can provide an avenue to paying off your student loan debt, their terms and conditions narrow the number of homeowners who can best take advantage of them.
Pros of Using Home Equity Loans to Clear Student Loan Debt
The primary benefit of using a home equity loan to pay off student loans is that the funds are disbursed as a lump sum. As such, you may immediately use the funds to pay off all of your student debt. Since you’ll still need to pay off the loan, doing so consolidates it all into one monthly student loan payment.
Depending on your financial situation, the 15-year repayment term common to home equity loans could provide some breathing room, or it may simply push your student debt obligation further down the road.
Cons of Using Home Equity Loans to Clear Student Loan Debt
The first and most important consideration any prospective borrower must account for when evaluating whether a home equity loan is right for them remains the use of your house as collateral. If you cannot meet your repayment agreement with your lender, you risk losing your home altogether.
The second consideration is whether consolidating your student loans by using your home equity even offers a better financial situation. If Direct Subsidized or Unsubsidized Loans comprise most (or all) of your educational debt, the interest rates on a home equity loan or line of credit may cost you more.
Interest Rates—Student Loans vs. Home Equity Options
The interest rate for a home equity loan will vary according to your financial situation but will likely be set higher than for your initial mortgage.
As of July 2021, the average mortgage interest rate has floated between 2.90% and 3.03% for the last year, so you should expect something above 3% on a home equity loan. The average interest rate for a $50,000 HELOC with an 80% loan-to-value ratio (i.e., your mortgage amount divided by your property’s appraised value) sits at 4.29%. Federal student loan interest rate has a fixed rate at the following percentages:
- Direct Subsidized or Unsubsidized Loans (Undergraduate Students) – 3.73%
- Direct Unsubsidized Loans (Graduate or Professional Students) – 5.28%
- Direct PLUS Loans (Parents, Graduate, or Professional Students) – 6.28%
Therefore, if lenders offer a higher interest rate on a home equity loan or HELOC that currently applies to your student loan debt, consolidation will result in paying more.
Home Equity Loans Are Less Advantageous Now Than Before
One major tax reform change signed into law in the last few years greatly diminished the advantages home equity loans once offered homeowners: the Tax Cuts and Jobs Act of 2017. This act temporarily restricts tax deduction claims on home equity loan interest, first allowed under the Tax Reform Act of 1986, “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
The temporary removal of tax deductions outside of purchasing, building, or improving the home used as collateral means that you cannot currently claim such when using home equity loan to pay off student loans or other education expenses.
A Home Equity Alternative for Student Loan Repayment
To reap the benefits of a home equity loan without the disadvantages or high barriers to approval (such as credit score requirements), consider looking into a sale-leaseback program. Through sale-leaseback solutions, you can convert your home’s equity to cash by selling your home and leasing it back. After that, you can use your home equity to pay off student loans or other debt and living expenses while still living in your home.
Student loans have become a common monthly expense for American homeowners. If you’re in this situation, you may have considered using your home equity as a means of repayment. You can even use a home equity loan for debt consolidation. If you are still unsure of alternative options to securing this loan, consult your financial advisor to discuss more options.
- Business Insider. The average HELOC interest rate by loan type, credit score, and state.
- Experian. How Does a Home Equity Loan Work?
- Federal Student Aid. Understand how interest is calculated and what fees are associated with
your federal student loan. https://studentaid.gov/understand-aid/types/loans/interest-rates
- Federal Trade Commission Consumer Information. Home Equity Loans and Credit Lines.
- Investopedia. Home Equity Loan. https://www.investopedia.com/terms/h/homeequityloan.asp
- IRS. Interest on Home Equity Loans Often Still Deductible Under New Law.
- Statista. The student debt crisis in the U.S.
- U.S. Census Bureau. Quick Facts. https://www.census.gov/quickfacts/fact/table/US/SEX255219
- Washington Post. Mortgage rates are driven down to their lowest levels since winter.