Should You Use a Home Equity Loan or HELOC to Pay for College?
If you want to help your children pay for college, it generally isn’t cheap. College seems to get more expensive every year for millions of Americans.
Hopefully, you’ve saved money in advance to pay for the college costs. If you haven’t, you definitely aren’t alone.
Even so, many parents don’t want their kids to struggle with student loan debt.
There are many ways to help pay for your child’s college expenses. You could pay out of your income, sell investments, take out Parent PLUS loans or take out a home equity loan or line of credit.
Taking out a home equity loan or line of credit to pay for college costs is a unique solution.
It isn’t the right move for everyone, but it can make financial sense in some situations.
It will depend on your financial position, your other options to pay for college and how prepared you are for your own future.
You must be aware of the pros and cons of using your home equity instead of a student loan to pay for college costs before you decide to do so.
Here are some of the things you should consider.
Note: As always, make sure you consult with your financial advisor to get specific advice about your unique financial situation.
Why You Might Consider Tapping Your Home Equity
There are many reasons you may consider tapping your home equity to pay for your child’s college costs.
Large amount of equity available
For many people, their home is their largest asset. If you’ve had a mortgage for a few years, chances are you’ve paid off a portion of the balance owed.
Home prices might have risen over that time, as well. This combination could leave you with significant equity in your home.
If you have good credit, a home equity loan or line of credit might offer lower loan interest rates than other borrowing options to pay for college expenses.
Long repayment periods
Additionally, some home equity loans or lines of credit may have longer repayment periods.
A long repayment period can stretch out payments over more time which lowers the monthly payment of most loans if all else is equal.
For others, using home equity to pay for college costs could be a strategic move.
If you have investments you’d rather not sell, using your home equity could be a low cost way to pay for college expenses now while allowing your investments to continue growing.
There are two main types of home equity loans you may want to consider. They are a home equity loan and a home equity line of credit. Here’s what you need to know about each type.
How a Home Equity Loan Works
A home equity loan is more straightforward than a home equity line of credit. That said, they aren’t as flexible which can cause issues when trying to pay for college expenses.
In order to take out a home equity loan, you must usually leave at least 20% equity in your home after you take out the money to pay for college costs.
With a home equity loan, you borrow a set amount of money from your home’s equity on a single date.
You aren’t able to take out additional money in the future unless you take out a new home equity loan. This can cause problems because college costs usually occur over a four year period.
Because you have to borrow all of the money up front, you’ll pay mortgage interest on the whole balance even though you won't use some of it for three years.
If you underestimate the amount of money you need to borrow, you have to find another way to pay the remaining costs which could get expensive depending on how you go about it.
Home equity loans are usually repaid over anywhere from five to thirty years with fixed interest rates. You generally start making payments immediately after the loan closes.
To take out a home equity loan, there are costs involved. You typically have to get your home appraised and meet other requirements.
These costs, called closing costs, can add a significant upfront cost to your loan. Make sure to consider these as a cost of borrowing, as well.
Once the loan closes, you’ll receive the amount you borrowed. You then use that cash to pay for college expenses.
How a Home Equity Line of Credit (HELOC) Works
A home equity line of credit, commonly called a HELOC for short, also allows you to access the equity in your home.
However, it doesn’t require you to withdraw everything you want to borrow on a single date. Instead, there is a draw period during which you can borrow money from your line of credit up to the limit the lender sets.
You may have checks or a debit card tied to the HELOC that you can use to make draws. You can use these payment options to pay for college expenses.
The draw period usually lasts anywhere from five to ten years. This gives you plenty of time to take out the money you need to pay for a typical four-year college degree for your child.
During this draw period, interest charges are added to the loan balance based on a variable interest rate. In most cases, you don’t have to make any payments during this period.
Once the draw period ends, a repayment period begins. When you enter the repayment period, you can no longer withdraw money.
Repayment periods usually last from 10 to 20 years. You’ll have to make regular payments to pay down the principal while continuing to pay interest.
The monthly payment will depend on the amount you borrowed, the interest rate, and the repayment period.
Should You Borrow From Your Home Equity for College Expenses?
Now that you understand how home equity loans and lines of credit work, should you use one to pay for your child’s college expenses? Here are the pros and cons for you to consider.
A home equity loan or line of credit allows you to use your home equity for something useful rather than letting it sit unused.
A debt-free college education can give your child a huge financial advantage. Even with help from Mom and Dad, students should still try to pick an affordable college and be financially responsible.
In many cases, choosing to use your home equity could allow you to avoid selling investments.
Historically, investment returns have exceeded the extremely low interest rates offered on home equity loans and lines of credit today. Of course, past returns can’t predict future returns so there is a risk that things may not go as planned.
Speaking of low interest rates, home equity loans and lines of credit might even offer lower interest rates than a Parent PLUS student loan. That said, students can usually get lower interest rates by taking out direct subsidized or unsubsidized loans.
Your monthly payments might be lower on a home equity loan or line of credit, too. Usually, Parent PLUS loans are repaid over 10 years.
Home equity loans and lines of credit can often be repaid over 5, 10, 15, 20 or 30 years. The longer loan term you pick, the lower your monthly payments will be if all else is held equal. You’ll pay more interest on longer loans, though.
There are many reasons why you shouldn’t use a home equity loan or line of credit to pay for your child’s college costs.
First and foremost, tapping your home equity may mean you can’t afford to help pay for college.
If you don’t have any assets other than your home equity, you should focus on putting yourself in a better financial position. Paying for your child’s college should be secondary.
You can’t take out a loan to pay for retirement, but your kids can take out loans to pay for college. In fact, learning to pay off student loan debt can help a child take control of their finances.
A home equity loan or line of credit is a loan secured by your home. If you cannot make payments and default on the loan, the lender could foreclose on your home.
Taking out a Parent PLUS Loan is an unsecured loan. They can’t foreclose on your home if you default on it.
Unless you plan on paying off the home equity loan yourself, you shouldn’t let your kids use your equity to pay for college.
The loan will be in your name, so you can’t force your children to repay it. This can lead to messy family situations due to the large cost of college.
One benefit of having your kids take out student loans is they have multiple repayment options to choose from.
These options can provide flexibility on how the loan is repaid which generally isn’t possible with a home equity loan. Your child may even qualify for loan forgiveness which isn’t an option with a home equity loan.
Interest paid on home equity loans used to pay for college costs doesn’t count as student loan interest. That means neither you nor your child can take a student loan tax deduction for the home equity loan interest you pay like your child may be able to if they took out actual student loans instead.
While home equity loans or lines of credit may come with smaller monthly payments, they can take longer to repay in some cases.
You can normally pay these loans off faster if you wish. However, you’ll be stuck repaying the loan for longer than you would with a Parent PLUS loan if you don’t.
Even if you secure a lower interest rate with a home equity loan, the stretched out repayment period may result in paying more interest.
Ultimately Your Decision
It’s your decision whether you use your home equity to help pay for your child’s college costs.
In general, you should make sure you’re in great financial shape before you consider helping your kid pay for college. It doesn’t matter if you use home equity or student loans. Your financial security should come first.
Carefully weigh the pros and cons, as well as your alternatives, before deciding whether using a home equity loan or home equity line of credit is your best choice.
Alternative options could include traditional student loans, 0% APR introductory offers on credit cards, personal loans and private student loans.
It may also make sense to consult a financial advisor to have them take a look at your specific situation and offer recommendations.
They may be aware of alternatives you haven’t found that could work out better for you.