Should You Refinance Student Loans with a Mortgage?

Should You Refinance Student Loans with a Mortgage?

Homeowners who have mortgage payments as well as student loans from either their own education or their children's education, have the option to cash out their home equity and use the loan proceeds to pay off student loans, or refinance their student loans into their mortgage. By using these options, homeowners may be able to, in certain circumstances, save money with potentially a lower interest rate and lower monthly payments, but they could also end up paying more in interest over the life of the loan. There are some realities to consider before using a mortgage to reduce or eliminate student loan debt.

We are not providing tax or financial advice. We encourage you to consult a financial advisor and a tax professional to determine any tax implications. Please also see IRS Publication 936 and IRS Publication 970 for more information, visit www.irs.gov or call the IRS at 1-800-829-1040 (TTY 1-800-829-4059).

Borrowers Must Have Equity in Their Homes

Mortgage lenders require homeowners to have a certain loan-to-value ratio in their homes, which is how much is owed on the mortgage versus the home's current market value. For example, if a lender requires an 80 percent loan-to-value ratio, then a homeowner would need to have enough equity in their home after taking an additional mortgage to still retain 20 percent equity in the home. That could be a difficult hurdle for homeowners who haven't owned a home long enough to build up substantial equity.

Debt is Not Eliminated, It Just Changes Form

Paying off or refinancing student loans with a mortgage doesn't reduce or eliminate the debt; it simply trades one form of debt for another.

If you choose to refinance your current mortgage using a home equity loan, rather than taking out a separate home equity loan, that means you will be refinancing to a new loan with a 10- to 30- year repayment term. Since the loan is reset and the loan amount increases due to the extra cash you're taking out, you could pay more in interest than your current mortgage interest plus the student loan interest.

This also puts homeowners at risk of carrying a mortgage into their retirement years, a move that may not be financially prudent. Homeowners who do take advantage of their home equity should set up a plan to pay off the mortgage before they retire. Another option is to take out a shorter-term loan if the monthly payments are manageable, which would also save on the amount of interest paid.

Different Hardship and Forbearance Options

Student loan lenders typically offer programs designed to help students avoid defaulting on their loans. These programs vary by lender and loan type, but the two common options are deferment and forbearance. These options may be different or not be available under the terms of a mortgage.

Deferment

Students who return to school, are on active military duty, serve in a public service organization or are completing a medical residency may be eligible for deferment, which is a temporary postponement of loan payments. However, while payments are postponed, interest will continue to accrue.

Forbearance

Those who experience an economic hardship due to unemployment or a medical disability may qualify for forbearance, where payments are postponed or the loan's interest rate is reduced for a period of time — generally from six months to a year. Like deferment though, interest will continue to accrue while payments are postponed.

Similar to student loans, mortgage lenders may have programs to assist homeowners experiencing financial hardships, and these will vary in type and availability by lender. When considering your options, it's important to understand what assistance is available, should you need it in the future.

Borrowers Could Lose Tax Benefits

Conventional wisdom dictates that mortgage debt is "good debt" because the interest is tax-deductible. The Tax Cuts and Jobs Act (TCJA) of 2017, however, could affect anyone considering using home equity to pay off student loans.

Prior to January 1, 2018, there were tax advantages when refinancing student loans with a mortgage. However, the new law eliminated the tax benefits of home equity debt, unless that debt is used to buy, build or substantially improve the home.

To illustrate, say a borrower has a home worth $250,000, a mortgage of $100,000 and student loans totaling $20,000. Before the TCJA, the borrower might have been able to refinance into a new $120,000 mortgage and claim an itemized deduction for interest paid on the full $120,000 mortgage.

Under the new law, if the $20,000 was used to pay off student loans, only interest on the first $100,000 of mortgage debt is deductible. Complicating matters further, Form 1098 — the form mortgage lenders use to report the amount of mortgage interest paid during the year — doesn't track deductible mortgage interest versus non-deductible mortgage interest. It's up to taxpayers to keep records for how loan proceeds were used and calculate the deductible portion.

This provision of the TCJA is due to expire after December 31, 2025. In 2026, unless Congress changes the rules again, the IRS will revert to the old rules.

Keep in mind that student loan interest is still deductible for qualified education loans as long as your income is below the phase-out limit ($80,000 for a single filer or $165,000 for a married couple filing jointly). The student loan interest deduction is an "above-the-line" deduction, which reduces your Adjusted Gross Income (AGI).

Borrowers Could Lose Their Homes

Mortgage debt is secured by collateral: the home. When a borrower defaults on a mortgage, the lender generally has the right to foreclose on the home. Defaulting on a student loan damages the borrower's credit and could result in garnished wages or a lien on property, but doesn't jeopardize their home.

Paying off or refinancing student loans with a mortgage may help you reduce your monthly payments and/or get a lower interest rate. Carefully compare your options to make the best decision for your situation.