Home equity can finance college

The motto for the University of California is Fiat lux, Latin for "Let there be light."

A lovely sentiment, but most parents of college-bound students have another, more practical wish: Fiat pecunia, or "Let there be cash."

The average cost of college tuition, room and board now hovers around $22,000 a year, according to the College Board. Even state schools average $10,000 a year, while the annual price tag for an Ivy League school can easily top $30,000.

There are, of course, numerous sources of financial aid for college-bound students. But many upper-middle-class parents find themselves in a gray zone: too wealthy to qualify for financial aid but not flush enough to bankroll four years of college. Baby boomers who haven't saved enough money for college are sometimes forced to dip into their retirement savings or borrow from their 401(k) plans.

Fortunately, there are other sources of cash for college that won't jeopardize your golden years. One is as close as your front door: a home-equity line of credit.

Homeowners have long used home-equity loans and lines of credit to pay for a new roof or bigger kitchen. But depending on your circumstances, a home-equity line of credit could also help you pay for college. Some advantages:

Lower rates. Home-equity loans and lines of credit are secured loans because your house is collateral for the loan. For that reason, the interest rate on a home-equity loan may be lower than rates for an unsecured student loan.
Home-equity rates are typically tied to the prime rate, which is the interest rate banks charge their best corporate customers. Now, lenders are offering home-equity lines of credit for less than 1 percentage point above the prime rate. The prime currently stands at 7.75%. The average rate on a home-equity line of credit is 8.68%, according to HSH Associates, a mortgage consulting firm.

In addition to traditional lenders, some colleges offer their own home-equity loan programs, often at competitive rates, says Kalman Chany, author of Paying for College Without Going Broke.

Less equity, more aid. Most state schools exclude the value of your home when calculating your eligibility for financial aid. But many private college financial aid offices count equity in your home as an asset in determining your net worth. When you borrow against your home, you reduce your equity, improving your chances for private-school aid.
More flexibility. With a home-equity loan, you typically get a specific amount of money, usually at a fixed interest rate. A home-equity line of credit works more like a credit card: You can borrow money when you need it, up to a set limit. That makes it a convenient way to pay . If your child wins a scholarship after the first semester, you can leave the loan alone.
Lower taxes. Unlike most other types of loans, home-equity loans and lines of credit are usually tax-deductible.
Peggy Ruhlin, a financial planner in Columbus, Ohio, says some of her clients are using home-equity loans for college costs even though they have enough in their investment portfolios to cover tuition. That way, she says, they can continue to earn money on their stocks and mutual funds. And by holding on to their investments instead of selling them, they avoid paying capital gains taxes.

When not to borrow

Don't even think of borrowing against your house until you've explored other sources of financial aid. If your child qualifies for a Stafford or Perkins loan, take advantage of those federally subsidized programs first, Chany says. Interest on Stafford and Perkins loans is deferred until your child finishes college, making them much more attractive than home-equity lines of credit, he says.

In addition, talk to your child's school about its student loan programs. Some student loans are available at more attractive interest rates than home-equity loans, Chany says.

If those alternatives prove unsatisfying, be aware of the pitfalls of a home-equity line of credit:

Like a credit card with a big limit, a home-equity line can tempt you to borrow more than you can afford to repay. If that happens, you could lose your home.
The interest rate on your home-equity line of credit could rise.
Because the rates are tied to the prime, an increase in that benchmark will boost the cost of the loan. Many economists think the Federal Reserve will raise rates later this year, which could cause banks to raise the prime.

If you're worried about rising rates, Ruhlin suggests another alternative: Refinance your home, take some cash out and use the money to pay for college.

There are a couple of advantages to this strategy, she says. Mortgage rates are lower than home-equity lines of credit, so you'll pay less for the money you borrow. If you refinance with a fixed-rate mortgage, you won't be affected by rising interest rates. And if you later find you won't need all the money, you can refinance again, pay down part of the mortgage and reduce your monthly payment.

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Paying Student Loans With Home Equity

When students graduate from college, they begin to enjoy the fruits of their labors. Many land good jobs, and some buy new homes. After a few years of home ownership, if the market is rising, they may also eyeball their student loans, and consider the pros and cons of using a home equity loan to pay off their debts.


If you're a college graduate with student loans, you probably envision having to pay your debts for years to come. While the prospect of becoming debt-free seems like a pipe dream, it can happen much sooner if you manage your debt intelligently. But does smart debt management include using a home equity loan to pay off your student loans? Like anything in the financial world, this option has a variety of pros and cons.

Lower rate, tax deductible interest
At first glance, consolidating your student loans into a home equity loan seems like a no-brainer. Because a home equity loan uses your property as collateral, banks can offer it at a lower rate than most private student loans. The lower rate alone can save you thousands of dollars in long-term interest payments, and you also get added tax benefits. Interest paid on a home equity loan is tax-deductible, which will lower your overall costs.

A home equity loan is a fixed-rate, fixed-term loan. The fixed rate can be extremely appealing, as private student loans often include variable rates. If you're conservative with your money, eliminating uncertainty may help you sleep better at night.

A home equity line of credit (HELOC), which is a line of credit based on the equity in your house, will also help you pay off your student loans. As an added bonus, you can use the HELOC as an emergency source of funds if you get into a crunch. The interest is still tax-deductible, but be forewarned: the rate on a HELOC is variable, and can spike upwards.

Notice the rewards; consider the risks
Choosing a home equity loan to repay your student indebtedness has plenty of rewards, but you do need to be aware of the risks. First and foremost, a home equity loan uses your house as collateral. If you run into tough times, and have to default on your mortgage, you could lose your home.

While you'll gain a tax deduction for interest paid on your home equity loan, you'll lose the deduction that comes with student loan interest. You'll need to run the numbers to see which loan benefits you the most.

The future for most college graduates will include years of debt payments. Between mortgages and student loans, it may seem like you'll be mired in debt until the end of time. However, smart management of these debts-such as paying off your student loan with a home equity loan-can save you thousands of dollars. Understand your options, and you'll be on your way to a debt-free life.


Paying Student Loans With Home Equity
By: Greg Mischio

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Should we use home equity to pay off student loans?

Should we use home equity to pay off student loans?
by Liz Pulliam Weston
Dear Liz: Our question is about student loans.

We have a total of $69,000 in education debt. We also have a home worth $400,000 and our mortgage balance is $266,000, plus a home equity loan with a balance of $14,500.

We make a good salary, have excellent credit, pay all our bills on time, and, if gas weren't so darn high, we would have a decent amount of discretionary income.



We make extra principal payments when we can. The problem is that interest rates on our school loans are climbing, and payments are getting higher and higher.

We're wondering whether we should take out another home equity loan to pay off the student loans.

That would obviously leave us with less equity, which could limit the price we could pay on the house we plan to buy in three to five years.

But it would also decrease our monthly loan payment significantly and we would be able to deduct the interest on the home equity loan. (We can't deduct student loan interest because we make too much money.)

Does a home equity loan make sense in this case?

Answer: Generally speaking, trading student loan debt for home debt isn't a great idea.

Student lenders typically are much more flexible than mortgage lenders, with a wider variety of repayment options. You also can get a deferment or forbearance if you lose your job or otherwise encounter a financial hardship. This respite from payments can last as long as three years on many student loans.

Compare that with what would happen if you couldn't make your mortgage payments. Within a year, and usually much less, your home lender would start foreclosure proceedings.

In addition, most student loan debt can be consolidated. This would allow you to lock in your current interest rate and perhaps lengthen the repayment term to lower your monthly payments.

A longer loan means you would pay more interest over time, but it could help ease the monthly crunch you're feeling.

All that said, not being able to deduct the interest on your student loans is a significant disadvantage.

If you're confident you'll be able to make the payments, then you might consider paying off at least some of your student loan debt with home equity borrowing.

You should, however, limit your total borrowing — all your home equity loans plus your primary mortgage — to no more than 80% of the value of your house.

You want to keep at least a 20% equity cushion in your home whenever possible, as a last-resort emergency fund and also to protect yourself in case of declining home values. (You don't want to be faced with having to sell your home and owing more than it's worth.)

Given the loans you already have, you should be able to pay off $39,500 of your student loans with home equity debt. Then you could consolidate the remaining $29,500.
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Liz Pulliam Weston is the author of "Deal with Your Debt: How to Manage Your Bills and Pay Off What You Owe" and "Your Credit Score: How to Fix, Improve and Protect the 3-Digit Number that Shapes Your Financial Future." This column may not be resold, reprinted, resyndicated or redistributed without written permission from its distributor, No More Red Inc.

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