You may have heard that tapping into home equity is a great way to bridge the gap in paying for college. Certainly, many families find that federal student loans and other financial aid is not enough.
However, as with all types of debt, there are pros and cons of using home equity to pay for college. Understanding the benefits and risks will help you make the right decision for your family.
Benefits of Using a Home Equity Loan to Pay for College
Home equity is the portion of your home that you have paid off. You can build equity by making your mortgage payments for many years, or you can gain equity if the value of your home increases.
Either way, your home equity is an asset that can be an inexpensive way to pay for major expenses, including your student’s college education.
There are two ways to use your home equity to pay for college. You can get a lump sum home equity loan, or you can set up a home equity line of credit (HELOC).
Here are some benefits to using home equity in this way:
Easy to Qualify For
Because your home is the collateral for the loan, it’s generally easy to qualify for home equity credit. As a result, it can be set up quickly and provide the funds you need.
If you use your home, you don’t end up cosigning on a private loan for your child. You can also avoid costly parent-focused private loans.
Home Equity Debt Can Be Cheaper
A home equity loan will generally have a fixed interest rate, which can be hard to find on a private loan. A HELOC will have a variable interest rate, but will still likely come in lower than a Parents PLUS loan.
Unless you do a full refinance to pay for college, you will probably have lower loan fees using home equity than a private loan as well.
Larger Amounts of Money May Be Available
Federal student loans are inexpensive and have flexible repayment terms, but they have annual caps on borrowing. Even when you have financial aid from the school or other scholarships, you might face a cost gap.
Your home equity can provide you with enough money to cover those costs without tapping into retirement accounts or more expensive private options. A HELOC gives you especially great flexibility, because you can simply use the amount you need rather than withdrawing a large lump sum.
Another parent in the Paying for College 101 Facebook group took advantage of a HELOC, saying, “we had to go that route, as we had two children in college at the same time. We have a line of credit so we only use it as needed after scholarship, grants, Work-Study, and a monthly payment plan to the colleges.”
You Don’t Have to Borrow From Retirement Savings
Borrowing from your 401(k) may be the riskiest way to pay for anything, including school. You miss out on tax-deferred growth, and you may not be able to contribute to the account until the loan is paid off.
Most of all, if you are laid off or change jobs, the full amount of the loan is due immediately. Because you never know when these things could happen, a 401(k) loan is not a good option.
If you’re a homeowner, a home equity loan, sometime called a second mortgage to pay for college, is a much better option.
Drawbacks to Using Home Equity for College
Before you jump into using a home equity loan to pay for college, be sure you understand the pros and cons of using home equity for paying for college.
Here are some drawbacks.
You’re Improving Your Child’s Earning Potential, Not Your Own
Many times using a home equity loan makes sense if you’re doing something that will increase your own income or help you develop professionally. These changes can help you earn more, making it easier to afford the loan.
When you use your home equity for your child, your professional situation doesn’t change.
Your child may be better off, but you have taken on extra debt without any new ways to afford the payments.
You Could Lose Your Home
If you fail to repay a standard loan, your credit could take a major hit. However, you will probably be able to keep your home.
If you cannot repay a home equity loan, however, your home is the collateral. The bank will take your house as a way to recoup their money, leaving you with nowhere to live.
Remember, you don’t know what the future holds. Your home may not continue to increase in value, or you may lose your job or face an illness. Not having contingency plans in place can jeopardize your living situation.
One of the parents in the group agreed, saying, “I think it’s a big mistake. If you lose your job, your home is on the line. If possible, loans should be the burden of the student, not the parent.”
Less Flexibility in Repayment Options
Federal student loans and many other college funding options have a variety of repayment plans. You or your student may be able to take breaks during times of financial difficulty.
There may even be loan forgiveness options available in certain circumstances.
When you use home equity for college, you don’t have those options. You have to stick to the repayment plan you’ve been given, although you can usually pay it off early without a penalty.
Can College Be More Affordable?
College is expensive, there’s no doubt about it. But there are things you can do to make it more affordable.
Some schools are better than others and providing aid. Other times, your student can take advantage of part-time work or additional scholarships to pay for school.
If you’re looking for help figuring out how to pay for college, Road2College is here for you.
We have information about which schools are most generous, along with many tips and tricks to make college less expensive.
For more information, check out our College Insights tool today.
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