Why Not Use a Student Loan Instead?
The interest rate on student loans is usually pretty good, and interest is tax deductible up to $2,500 a year. If a graduate defaults, it impacts his credit score, but he doesn’t ‘lose’ his degree. On the downside, the substantial amount of debt associated with student loans is a burden for someone starting on the career ladder. This form of debt is the main reason why so few graduates can afford to purchase a home.
If you have a child that is ready for college, do you want them to be pressurized by the specter of repaying student debt? Or would you rather use your home’s equity to give them the freedom not only to graduate but also to explore employment options that allow for a bright long-term future; instead of scrambling for any available job to pay the bills?
How Does a Home Equity Loan Work?
Equity is the amount of money you have paid into your home’s principal, or that it has appreciated over time. If you have paid $80,000 of a $320,000 mortgage, you have 25 percent equity in your home and are a candidate for a home equity loan. There are two options:
- Standard Loan: This works like a second mortgage. You receive a lump sum and agree to repay it at a certain interest rate over a specified period. You can choose a fixed or adjustable rate loan.
- HELOC: The Home Equity Line Of Credit option is a variable rate loan with a twist. Instead of borrowing a fixed amount, you borrow money as you need it and repay it. Once the pre-agreed term ends, you must pay off any outstanding amount.
Pros & Cons of Using a Home Equity Loan to Pay for College
Pros
Lack of Restrictions
Many banks won’t lend less than $15,000, a home equity loan gives you a lot of freedom compared to student loans which have restrictions. The Department of Education has annual limits on federal loans: $5,500 in year one, $6,500 in year two and $7,500 in years three and beyond.
Quickfire Process
If you need money in a hurry for college expenses, an HELOC is incredibly convenient. You can just write a check from the line of credit and immediately handle the issue. Private student loan applications are a much more difficult process.
Low Fees & (Potentially) Tax Deductible
Home equity loans carry lower interest rates than most other types of borrowing; in fact, they compare favorably to student loan rates. Most home equity loans have rates in the 5-6 percent range, almost the same as federal Stafford loans and lower than federal PLUS loans made to parents. Also, the interest paid on the home equity loan could be tax deductible.
Cons
The House is Collateral
If you don’t pay back a student loan, you don’t lose your education. If you default on a home equity loan, you could lose your home. Financial experts say it is a case of putting a ‘hard’ asset on the line for the sake of a ‘soft’ asset.
Lack of Flexibility
While an HELOC offers some semblance of flexibility, standard home equity loans are more rigid. There is no way to get the money back if you undergo a period of financial difficulty. Lenders routinely offer assistance to those struggling to repay student loans including reduced rates and increased payment periods.
As well as your current financial situation, taking out a home equity loan to pay for college depends on how you view higher education. For what it’s worth, a survey conducted amongst millionaires revealed that 66 percent of them believe a college education is worth taking on debt for as it was their education that helped them achieve success.
How Valuable Is Your Child’s Education?