One of the most common questions homeowners with student loan debt ask is, “should I use the equity in my home to pay off my student loan debt.” The answer to that question is, it depends. There are several factors to look at before you use the equity in your home to refinance your student debt. This blog post will examine several scenarios where it is beneficial or counter-intuitive to refinance your student loan debt with a home equity loan.
Are You Paying A High Rate On Your Student Debt?
If you are paying a high interest rate on a student loan then it might be a good idea to refinance that loan at a lower rate with the equity in your home. Home loan rates are often times lower than unsecured student loan debt and a few percentage points reduction in your interest rate could mean thousands in savings. For example, lets say you have $30,000 in student loan debt at a 6.5% interest rate. If you are able to refinance that loan over 30 years at a 4% interest rate then you will save almost $17,000 over the life of the loan. Lets say you take the monthly savings from the interest rate reduction and you invest that money at a 6% interest rate; at the end of 30 years you will have over $46,000. If this is your first time refinancing your home then you can get double the savings by lowering the rate on your original home loan as well. However, if the interest rate on your student loan is close to or lower than your home loan rate then it wouldn’t make sense to refinance.
Do You Make More Than $80,000 a year ($160,000 for couples)?
If you make more than $80,000 a year then chances are you won’t be able to deduct any of your student loan interest for federal tax purposes. The student loan interest deduction allows taxpayers to deduct up to $2,500 in student loan interest per year. However, this deduction completely phases out at adjusted gross income over $80,000 for individuals and $160,000 for couples. If you own a home then chances are you itemize your deduction and would be able to deduct your home interest against your income. If you pay more than $2,500 a year and make over these thresholds then it might make sense to refinance your student debt to benefit from these tax savings.
Home Loan Default vs Student Loan Default
One of the main reasons financial advisers suggest against refinancing your student loan with your home equity is that the debt from your student loan will now be collateralized against your home. They will argue that your home is your greatest asset and turning unsecured debt into secured debt is a bad financial move. The equity in your home can be a safety net for many home owners to borrow against in case of emergency and using up this fund to pay off student debt could put you in a worse financial position. However if you find yourself in a situation where you lose your job and can’t pay your mortgage then chances are you won’t be able to pay your student loans either. The difference is mortgage loans go away after foreclosure and bankruptcy but student loans are forever.
Worse case scenario: you are unable to pay your mortgage and you have to go through foreclosure proceedings. You have no equity in your home because you used the equity to refinance your student loans. At the end of the day you lose your home but you are also free of any student debt because your student debt was in the form of a secured home loan. If you had student debt and you stop making payments then your wages could be garnished and you could find yourself in a worse financial position. However, if you want to keep the equity in your home in case of medical emergencies then it might be a good idea to keep your student loans separate.
Student Loan Forgiveness
The Public Service Loan Forgiveness (PSLF) program forgives the remaining balance on your Direct Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer. Employment with the following types of organizations qualifies for PSLF.
- Government organizations at any level (federal, state, local, or tribal)
- Not-for-profit organizations that are tax-exempt under Section 501(c)(3) of the Internal Revenue Code
- Other types of not-for-profit organizations that provide certain types of qualifying public services.
If you qualify for this program then it is not a good idea to refinance your student loans. Once you refinance your student loan you will be automatically disqualified for student loan forgiveness and will lose all benefits.
There is no one size fits all solution to the question of whether or not to refinance student loans with your home equity. However, if you are aware of your options you can make a well informed decision. Some financial advisers will always advise against using your equity to refinance any loan, secured or unsecured, while others feel it is another tool in the toolbox for homeowners to secure their financial position. Make sure to consult your financial adviser to find the best plan for you and your financial situation.