Should You Pay Off Student Loans With a HELOC?
With student debt reaching record highs, it might seem like you’ll never escape the burden of your student loans. If you own a home, but still have student debt, it might be tempting to take out a HELOC to pay off your debts. Though it might seem attractive, this is a bad idea and something to avoid.
Why You Might Consider It
HELOCs have many features that make it seem like using one to pay off student debt is a good idea.
It’s easy to do
All you have to do is apply for a HELOC from a lender. You can then use it to fill your checking account with enough cash to pay your debts. Send checks to your lenders, and you’ll have traded student debt for a HELOC.
Lower interest rates
One benefit of HELOCs over student loans is that they charge much lower interest rates. Student loans can charge 7% interest or more. HELOCs tend to charge much less. If you have a HELOC and student loan with the same balance and repayment period, the HELOC would cost you much less each month. The lower monthly payment can be tempting.
HELOCs also offered tax advantages that reduced their total costs. In the past, you could deduct up to $100,000 in HELOC interest from your income when you filed your taxes each year. With the new tax laws, this advantage has been removed, but you still get tax benefits on your mortgage.
However, student loans give similar tax benefits, so switching to a HELOC to pay less in tax won’t work.
Why It Is a Bad Idea
Using a HELOC to pay off your student loans isn’t just a bad idea, it can be very dangerous to your long-term financial health.
Trading unsecured debt for secured debt
One of the biggest issues with using a HELOC to pay a student loan is that you’re trading unsecured debt for secured debt. With a student loan, there is no asset backing the loan for the lender. If you default on your loan, the lender can take you to court, but it cannot start repossessing your property immediately.
A HELOC is secured by the value of your home. If you default on a HELOC, the lender can foreclose on your home. By trading an unsecured student loan for a HELOC secured by your home, you’re putting your home at risk if you become unable to make payments.
Variable interest rates
Some student loans have variable interest rates, but many have fixed interest rates. The benefit of a fixed interest rate is that you know exactly what your monthly payment will be, every month until the loan is paid. You can calculate the exact cost of the loan upfront.
Most, if not all, HELOCs have variable interest rates. How much interest will accrue each month will change as market rates change. If rates increase, you’ll wind up paying more, which means a larger monthly payment. If rates increase by a lot, you could wind up with unmanageable payments.
You might be in debt longer
If you only have a few years left on your student loans, paying them off with a HELOC could result in you being in debt for longer. HELOCs allow you to pay off your debt over the course of many years. Sometimes as many as 25 years. You also often only have to pay interest for the first handful of years. You could be setting yourself for a lifetime of debt and for a surprise when you have to start making higher principal payments by paying student debt with a HELOC.
HELOCs aren’t free to open and maintain. You have to pay fees and closing costs when you open your HELOC. You also have to withdraw a minimum amount, which might be more than you need to pay your loans. There are other fees that you might be charged just to keep the HELOC open, reducing any savings you might get.
Makes it harder to move
If you have a HELOC, it might make it much harder to sell your house and move. Usually, a HELOC has to be paid off alongside your mortgage if you want to sell your house. If you cannot sell your house for enough to pay both your HELOC and the remainder of your mortgage, you’ll have to come up with the money to make up the difference before you can actually sell.
Also, Avoid Consolidating Student Loans by Refinancing Your Mortgage
A similar strategy to paying off your student debt with a HELOC would be to consolidate your debts into your mortgage while refinancing. This is a bad idea for many of the same reasons paying with a HELOC is a bad idea. You could wind up in debt for longer, paying higher fees, and not saving much on interest. Plus, you’ll have traded unsecured debt for debt secured by your house, putting your home at risk.
Though using a HELOC to pay off your student loans is a bad idea, there are some things you can do to pay your loans off faster or reduce your monthly payments.
Loan deferment and forbearance programs
One of the most common options for handling student loans is taking advantage of a deferment or forbearance program.
Loan deferment postpones payments on the loan. If you have subsidized federal loans, interest will stop accruing while the loan is deferred.
Loan forbearance temporarily suspends or reduces your monthly payments. Interest continues to accrue during this time.
You can be eligible for loan deferment if you meet one of these requirements:
- You are enrolled in school at least half-time
- You are enrolled in a graduate fellowship program
- You are enrolled in rehabilitation for the disabled
- You are unemployed and unable to find employment (up to three years)
- You are experiencing economic hardship
- You are active duty military
- You can be eligible for forbearance if you meet one of these requirements:
- You are serving in medical or dental internship/residency
- Your monthly payments are greater than 20% of your monthly gross income
- You are performing teaching service that qualifies for teacher loan forgiveness
You can also request forbearance for general reasons, which can be granted at the lender’s discretion.
One danger of forbearance is that your monthly payment might be reduced to the point where you are paying less each month than you are being charged in interest. In this scenario, your loan balance will grow until you can increase your payments.
These strategies can be especially helpful if you might be eligible for loan forgiveness. If you are employed by a non-profit or meet other requirements, your loan’s balance might be forgiven if you make on-time payments over a long enough period of time. Just be aware that you’ll have to pay taxes as forgiven loan balances are treated as income.
Balance transfer credit cards
Another option for reducing interest costs is to use balance transfer credit cards to pay some or all of your loans.
Balance transfer cards offer sign-up bonuses that reduce balance transfer fees and interest rates. Usually, you can get 12 to 24 months interest-free by using a balance transfer card. The danger is that you will wind up paying credit card interest rates if you fail to pay off the transferred balance in time. With responsible usage, they can help to reduce interest paid on your student loans
We advise this method only when your student loan balance is close to being paid off.
Another option, which is especially appealing to people with multiple student loans, is to consolidate those loans into a single personal loan.
Usually, personal loans, like student loans, are unsecured, so you don’t have to worry about trading secured debt for unsecured debt. Usually, interest rates will be similar, but consolidating multiple loans into one means you’ll have fewer monthly bills to handle.
You can also customize personal loans to have exactly the loan term you want, and choose whether the loan will have a fixed or variable interest rate. Just be aware that a variable rate personal loan is subject to interest rate risk. If rates increase, your monthly payments will increase too.
Paying off a student loan with a HELOC is a bad idea. While you may save some money on interest, you might wind up paying more if rates rise. You also put your home at risk if you ever wind up in a situation where you have to miss payments.
Instead of using a HELOC to pay off your student loans, continue to follow the payment plan set out by the student loan. If you really want to get out of debt quickly or reduce your payments, consider an alternative, but be aware of the risks.
In the end, you should treat your home debt and student debt differently. Set up a payment plan for each and follow it. If you have student debt and can afford a home, don’t be afraid to purchase on, but don’t plan to use the equity to accelerate your ability to pay other debts.