In today’s unpredictable COVID-19 employment environment, many Americans are feeling an economic pinch. Those who have student loans received temporary relief with the government CARES Act, but when that ends, some borrowers may be wondering how they are going to make their payments again. For homeowners, it may be possible to get a refinance loan to pay off all the student loan debt. But is this a smart solution?
Pros of Paying off Student Loans with Refinance Money
By taking out a refinance mortgage to pay off student loans, borrowers can consolidate their debts into one payment. And mortgage loans today offer record low interest rates than other debt, allowing you to pay a lower rate on your student loans when you refinance.
Cons of Using Home Equity for Student Debt
There are some potential dangers to using your home as a bank though. Your mortgage loan is tied to your house as collateral. If you are unable to make your payments on your mortgage, you could risk losing your home, while if you are unable to pay your student loan debt, your credit will be damaged but no asset will be lost.
If you have federal student loans, you may lose out on benefits that already reduce your debt burden like income-based repayment plans, public service loan forgiveness and loan deferent plans.
Plus, refinancing could stretch out the length of your mortgage loan, increasing the total amount of interest paid on your total debt in the long run. And new mortgage loans always include fees that could make paying off your student loans less cost-effective.
You could consider refinancing your student loans for better terms, if you do not want to put your home at jeopardy.
How Does it Work?
If you decide refinancing is the best option to pay off your student loans, here’s how it works: You get a cash-out refi loan that is larger than your current mortgage. You use the excess funds to completely pay off your student debt, effectively rolling them into your home loan. Now each month, your mortgage payment will be larger, but your overall debt interest rate will be lower.
Before you get started, first determine how much home equity you have. In general, lenders will allow you to take cash out of your home as long as you have at least 20% equity, but more is certainly better. The more equity you have the easier it will be to avoid becoming upside down on your loan and easier to sell your home in an emergency.
If you have enough equity, it’s time to consider the term. Do you want a new 30-year loan? That could potentially extend your loan past retirement in some cases. It could also increase the total interest paid significantly. Refinancing into a 15-year loan with a higher loan amount is likely to considerably increase your monthly. A 20-year mortgage might also be a possibility. Make sure the time frame and payment work for your situation.
With interest rates at rock bottom lows, using your home’s equity to pay off student loan debt could be a way to save money and streamline your finances. Just be sure the numbers all pencil out before you take the plunge.