The Pros and Cons of Using Home Equity to Pay for Education
Paying for college is no easy feat these days, and while you may qualify for federal student aid, there are other options. According to The College Board, the total annual cost of college is significant:
Thankfully, there are many ways to finance higher education. In fact, you may have overlooked some ways to pay for college when your federal aid caps out. This includes home equity loans.
What is a home equity loan?
Home equity loans are offered in many formats, which makes them flexible borrowing tools.
A home equity loan is a borrowing tool homeowners can use to turn the value of their home into cash in their hands (or college tuition).
As you probably already know, the longer you own your home and pay your mortgage, the more the cash value of your home increases. That cash value is known as equity. Basically, your home equity is the fair market value of your home minus any and all mortgages against the property.
For example, if your home is worth $250,000 and your current mortgage is $205,000, then $45,000 is home equity that you may be able to leverage using a home equity loan.
Depending on your lender, you may be able to borrow less than 90% of your total home equity, minus the value of the loan, which means you would have $40,500 available to pay for college.
Home equity loans are offered in many formats, which makes them flexible borrowing tools that you can tailor to your needs.
Traditionally, home equity loans are offered in one of three ways.
First, you have the traditional home equity loan. This is a home equity loan that becomes a second mortgage on your house and typically carries a fixed interest rate.
Second, you have the option for a home equity line of credit. This is a home equity loan that allows you to only borrow the funds when you need them, and you only pay interest on the funds you borrow.
Third, there’s a cash-out refinance loan which allows you to increase the amount of your current mortgage by refinancing your existing mortgage into a larger one, giving you the difference in cash.
Needless to say, home equity lending presents a myriad of options that you may be able to take advantage of as it relates to financing your higher education.
Why would I use a home equity loan to pay for college?
While some students use Federal Stafford Loans to pay for college, they offer limited funding. The maximum loan amount for a freshman is about $5,500. If you’re a sophomore, it is $6,500, and if you’re a junior or senior, it is $7,500.
Looking at the average tuition costs mentioned above, you can understand why students need additional loan options to pay for college. You can look at additional government funding through the Direct Plus Program. You can also turn to your home equity.
If you are a homeowner, or if you are a parent paying for your adult child’s education and you own a home, you are able to use the funds you’ve built up in your home for this major life expense. With a home equity loan, the only cap on borrowing is the equity you have available. Where you might need a federal loan, a personal loan and a private student loan to cover college expenses, you may only need a single home equity loan to do the same.
This is just one of the many advantages of using a home equity loan to pay for college. A home equity loan also offers competitive rates. Home equity loans from Discover home loans have rates from 3.99% - 11.99% APR*, depending on your creditworthiness. Federal Stafford Loans rates are 4.45% for undergrads and 6% for graduates from July 1, 2017 to July 1, 2018, while rates for Federal Plus Loans rates are 7% during the same time period. Both include a loan fee as well.
* Fixed rates starting at 3.99% APR for first liens and 4.15% APR for second liens.
The APR will be between 3.99% and 8.99% for first liens and 4.15% and 11.99% for second liens based on loan amount and a review of credit-worthiness, including income and property information, at the time of application. The lowest APRs are available to borrowers requesting at least $80,000 for second liens or $150,001 for first liens, with the best credit and other factors. Loan amounts available from $35,000 to $200,000.
Are there risks that come with using a home equity loan to pay for college?
All loans carry some type of risk if you fail to repay them. However, a home equity loan is unique in that your home secures the debt, which means your home is at risk if you fail to repay the loan.
For this reason, it is always essential to be sure that you can pay back the equity you borrow before you borrow from a lender. By taking out a home equity loan to pay for college, you are putting your home on the line for your education. However, a home equity loan is an installment loan with a fixed monthly payment, so you know what you’ll pay every month. A home equity loan with Discover offers terms of 10-30 years to help you choose a term and payment that fits your budget.
You may also find that some private colleges consider the net market value of your primary residence when doing their financial aid analysis, which may cause them to award you less money, causing you to consider a home equity loan more seriously.
Because the value of your home depends largely on the condition of your local real estate market, you risk becoming “upside down” on your home if the market drops. Being “upside down” on your home means you owe more money on your home than the home is worth. If the real estate market in your area isn’t healthy, this may be a valid concern for you.