These days, getting creative with your money puts you ahead of the game. One way you can consolidate debt is refinancing your home to pay off your student loan debt. That said, refinancing your home may not be the smartest option for everyone. To help guide you towards that decision, we’ve put together the following article. Because if there’s one thing we know about money, it’s that thinking your actions through can help you save money and set yourself up for success in both the short term and long run.
Types of Refinancing Available
Choosing to refinance your home can take many forms, including the following:
According to Freedom Debt Relief, a cash-out refinance “involves taking out a new mortgage for more than you currently owe. You’d use the loan proceeds to first pay off your existing mortgage loan and then use the extra cash you took out to pay for school or pay off student loan debt.” You’re basically taking out a large-sum loan to tackle all your debts, from a house payment to student loan payments.
Rate and Term Refinance
With this particular method, you’re changing the terms of your loan to free up money — basically the difference between what you owed and what the new monthly rate will be. This could be in the form of loan term and/or interest rate. For example, if you refinance your 15-year mortgage into a 20-year mortgage, your monthly obligations will go down. You can use that extra cash towards your student debt.
Home Equity Line of Credit
Most people have heard this phrase, often referred to as a HELOC for short. A word of caution: a home equity loan is a different animal than a HELOC. In a home equity loan, you “access equity without changing your current mortgage.” With a HELOC, the borrowing terms are much more open. In fact, they mirror the revolving lines of credit associated with a credit card. Once you’ve paid off even part of what you were loaned, you can continue drawing out money to pay off more debt. You’ll still have to pay off the HELOC though. It just might have better terms.
Traditional Student Loan Refinancing
When you first applied for your student loans, they came with a set interest rate that kicked in after you graduated. Traditional refinancing methods attempt to improve that interest rate by lowering it, effectively decreasing how much you end up owing in interest by the end of the loan term.
No matter which method you choose, there are pros and cons you’ll want to consider. Let’s take a closer look at what those might be.
Benefits of Refinancing
Choosing to refinance your mortgage to pay off your student debt has plenty of benefits. First, your debts are solidified into a singular payment. That means you won’t have to mark off all your debt payments throughout the month. Simply make the one payment and call it good.
This singular payment can also work in your favor in terms of debt-to-income ratios. By combining the two payments, you should be able to get a lower rate or monthly payment. That will, in turn, lower that debt-to-income ratio in your favor. This provides both short- and long-term benefits.
Speaking of lower rates and payments, a HELOC can extend your loan term from 5-15 years to up to 30 years. And as mortgage rates are “much lower than rates of credit cards, student loans and most other types of loans,” both of these features allow you to pay less in interest overall.
If you were to choose a cash-out refinance, there are some associated fees. However, “these fees are waived if you use the money to pay off student loans.” Achieving an interest rate of 3-to-4% and that longer 30-year loan term is entirely possible with a cash-out refinance. As we mentioned, these terms lower your monthly payments and give you more time to pay back the total amount borrowed.
Drawbacks of Refinancing
“So what’s the catch?” we hear you asking.
One of the biggest differences lies in secured vs. unsecured debt. Student loans are unsecured debt, since there’s nothing necessarily tangible connected with them (diplomas aside). Mortgages — and auto loans, for that matter — are secured debt, because your house (and car) can be taken away if you default. As such, inability to make timely payments can result in foreclosure.
The value of your home can be affected in other ways. For instance, if you take your home equity and pay off student debt, you could potentially “end up owing more than your home is worth.” Ideally you want to borrow less than what your home is worth, so you can still sell it for a profit when the time comes.
Profit — in the form of tax deductions — typically goes away with mortgage refinancing as well. You’ll “miss out on tax deduction opportunities” that come with owning a home, because home equity debt (including a HELOC) “is only tax deductible if it’s used for home improvements.” Student loan debt is not considered home improvement.
Finally, student loan debt is subject to “repayment plans, deferment, and/or forbearance.” You’ll lose access to these if you refinance your mortgage to pay it off. And in the end, “it will take longer to pay off your mortgage” and “the total spending on interest will be increased.” You may be able to pay off debts now and get a lower interest rate in some cases, but you’re still borrowing money that’s subject to interest over time.
What to Consider if You’re Thinking About Refinancing
With so many options to choose from, and both positive and negative consequences present, it can be hard to know which way to go. Below are a few things you’ll want to consider before making a move to refinance your mortgage to pay off your student loan debt.
- One of the first things you’ll want to research is what type of student loans you have. There are many benefits associated with each type of student loan. Refinancing them into a mortgage could, as we mentioned, preclude you from taking advantage of those benefits.
- Having enough equity to qualify should be another concern. “Most lenders won’t allow you to take more than 80-90% of your home equity in cash,” advises RocketMortgage. This is one of the ways to keep a homeowner from being upside-down in terms of the home’s value.
- When you take a cash-out refinance, you might be required to purchase private mortgage insurance (PMI) again. Read the fine print to find out if PMI is required in the terms presented to you. It’s just another expense you’ll have to pay, eating into any potential savings.
- Finally, you’ll want to shop around for the best rate. Just because you qualify for refinancing from one lender doesn’t mean that’s the first offer you should take.
If you’re not sure what to do, you can also talk to financial experts and even friends and family. They may be able to offer the experience you need to make the best decision possible.
Have Your Debt Your Way
We all inevitably find ourselves in debt throughout life. Student loan debt is considered to be “good” in the eyes of creditors, but there’s nothing like paying off the last cent you owed for a degree you earned years ago. We hope this article has helped you decide whether or not refinancing your mortgage is the way to go. A more-informed decision could be all that stands between you and a debt-free life.