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 schooling or their children's, have the option to cash out their home equity and use the proceeds to pay off student loans, or refinance their student loans into their mortgage. By using these options, homeowners can 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.

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 paying off student loans 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 Forms

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.

This also puts homeowners at risk of carrying a mortgage into their retirement years, a move that many financial experts advise against. 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 accrued.

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.

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. Similar to deferment though, interest will continue to accrue while payments are postponed.

Similar to student loans, mortgage lenders 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. However, to reap the advantages of a mortgage interest deduction, you must itemize deductions. On the other hand, student loan interest is deductible whether or not you itemize, as long as your income is below the phase-out limit ($80,000 for a single filer or $160,000 for a married couple filing jointly). The student loan interest deduction is an "above-the-line" deduction, which reduces your Adjusted Gross Income (AGI).

This means that homeowners who refinance and include their student loans into their new mortgage could lose some of their tax benefits by doing so.

To illustrate, say a borrower has a student loan and is able to take the above-the-line deduction for student loan interest. The same borrower also has a mortgage, but her itemized deductions are less than the standard deduction, so she receives no tax benefit from the mortgage interest payments. If the borrower refinances her student loans into a mortgage and her total itemized deductions are still less than the standard deduction, then she's lost the above-the-line deduction for student loan interest and isn't getting any benefit from the mortgage interest deduction because the standard deduction is still higher.

The tax implications of refinancing student loans with a mortgage depend on your individual tax situation.

Even with a larger mortgage, that scenario is a real possibility. With today's low mortgage interest rates, many taxpayers receive a bigger benefit from the standard deduction because the amount they pay annually for interest is so low. In fact, according to the Tax Foundation, more than two-thirds of households choose to take the standard deduction, meaning they receive no tax benefit from paying mortgage interest. You should consult with a tax professional to see how a cash-out refinance would impact you.

Borrowers Could Lose Their Homes

Mortgage debt is secured by collateral: the home. When a borrower defaults on a mortgage, the lender ultimately 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.

If you have a stable career and a secure income, paying off or refinancing student loans with a mortgage could help you reduce your monthly payments and get a lower interest rate. Carefully compare your options to make the best decision for your situation.

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 or call the IRS at 1-800-829-1040 (TTY 1-800-829-4059).