Going to college costs a lot of money. According to the Education Data Initiative, college-related expenses “more than doubled in the 21st century.” So it should come as no surprise that student loan debt is reaching stagging heights. At the end of the first quarter of 2024, it hit a staggering $1.6 trillion.
For individuals without the savings to cover the astronomical cost of college these days, tapping into home equity via a home equity loan is a very attractive option. In Q1-2024, Americans were sitting on $31.86 trillion in home equity. However, the most appealing choice isn’t always the best one for your overall financial well-being.
Key Takeaways
- Home equity loans can have lower interest rates than student loans but carry high risks.
- If you can’t make payments on your home equity loan, you could face foreclosure.
- Saving for college (if you have time to do so), scholarships, and cheaper schools should all be considered before taking out a home equity loan.
Advantages and Disadvantages of Using a Home Equity Loan to Pay for College
Advantages
You can borrow more money using a home equity loan than you would with student loans. This means you can give yourself a bigger cushion for unexpected expenses without using your own savings to foot the student’s college bill.
Home equity loans are often cheaper than other forms of debt. Since they’re secured by your home, they usually have lower interest rates, which saves you money in the long run. If you want to provide for your child’s education, a home equity loan may be the only way for you to come up with the large lump sum needed for a semester’s tuition.
Although you’re assuming the debt, you give your child a debt-free start after they graduate. You may be able to work out something when they get their first job to help contribute to repaying the home equity loan.
Home equity loans let you borrow against the available equity in your home. Check out Investopedia’s list of best HELOC loans of 2024.
Disadvantages
You put your home at risk by borrowing to pay for your child’s education. If your financial situation changes—you lose your job, your pay drops, your spouse/partner dies, or you have unplanned emergencies—you may not be able to repay the loan. The lender may begin foreclosure proceedings.
You’re adding to existing or assuming new debt. This can put a major dent in your financial situation, especially if you’re close to or already retired. It can also be a burden if you don’t have as much income as you did in the past.
You’re also taking on additional debt for someone who may not finish their studies or someone who may take longer to complete their education. The latter situation can lead to additional costs and expenses.
Pros
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You can borrow more money
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Better interest rates
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Child finishes college debt-free
Cons
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Your home is at risk if your financial situation changes
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You add to existing or assume new debt
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Your child may not finish or take longer to complete their degree
Advisor Insight
Thanasi Panagiotakopoulos, a certified financial planner and founder of LifeManaged, says using home equity to pay for college should be a last resort. His clients are typically in their last phase of accumulation and “do not have time to take on new debts heading into retirement.”
Alternatives to Using a Home Equity Loan to Pay for College
Paying for college can be tricky, especially with today’s extremely high costs. If you still have time before you need to pay for college, starting a 529 plan now and putting as much away as possible can put you in a better spot by the time the first tuition bill is due. The potential student may want to consider going to a more affordable school, getting their general education requirements through a cheaper community college first, and applying for every scholarship opportunity available.
If you are about to become an empty nester, then selling your home, downsizing to something smaller, and using some of the proceeds to pay for college can be a way to leverage your home’s equity without taking on additional debt.
While student loans can have shockingly high interest rates, they typically don’t become due for payment until six months after the student has graduated—and some loans, such as subsidized federal direct loans, don’t accrue interest during that time. While your student is still in school, you can start paying on their loans if you want to help them pay for college but don’t have the means to do it up front. Payments made while they are still in school will be applied directly to the principal and will help them pay off their loans faster after graduation.
What Is a Home Equity Loan?
A home equity loan is a loan for a fixed amount that uses the equity you have in your home as collateral for the loan. The loan has fixed monthly payments, typically with a fixed interest rate over a specified period of time. If you can’t pay your loan back, then you could lose your home to foreclosure.
Are Home Equity Loans Expensive?
Home equity loans are typically cheaper than unsecured debt, such as a personal loan or credit card, because they are secured by using the equity you have in your home as collateral.
Are Home Equity Loans Viewed as Assets for the Free Application for Federal Student Aid?
The Free Application for Federal Student Aid (FAFSA) does not count equity in your home against you, but once you take that equity out through a home equity loan, it will consider the money that you received through your loan as an asset offset by the debt of the loan. In addition to FAFSA, many individual schools have financial aid programs that may or may not consider equity in your primary residence when considering aid eligibility. Check with your school for specific rules.
Should You Co-Sign Student Loans?
Co-signing someone else’s student loans is risky and should be considered only as a last resort. Under current laws, student loans can be difficult to discharge through bankruptcy. If you co-sign on loans for someone who becomes unable to pay them back, then you’ll be on the hook for them.
The Bottom Line
Paying for college has become astronomically unaffordable over recent years at the same time that home equity has skyrocketed. Taking out a home equity loan to pay for college can be an attractive option, but consider the risks—namely, that you could lose your home to foreclosure if you can’t keep up with payments before signing up for the loan. There are many ways to make college more affordable, so be sure to exhaust all options before taking out a home equity loan to pay for it.
Read the original article on Investopedia.