Should I Refinance My Home to Pay Off Student Loans?

Michael Lux Blog, Strategy, Student Loans 0 Comments

If you have some equity in your house it might be tempting to utilize it to pay off your student loans.  With mortgage rates being near record lows and student loans being an ongoing burden, the idea definitely has some potential.  That being said, going this route can be a risky choice.

The “cash-out” refinance process is fairly simple.  A homeowner applies for a new mortgage, and they borrow more than what they owe on their current mortgage.  This extra money is often used for home improvement projects.  A growing trend has been to use the extra money to pay down student debt.

So should you refinance your house to pay off your student loans?

Answer: It might seem like a smart move, but it isn’t necessarily the smartest move.

Advantage: Cash-Out Refinance Can Eliminate Student Debt

Dealing with student loan debt is incredibly frustrating.  Many borrowers run into unexpected fees and monthly bills often are applied almost entirely to interest.

Using home equity to pay off student loans can entirely eliminate student debt for some borrowers.  For those with large student loan balances or high interest loans, this can result in a significant savings on student loan interest.  It can also free up some extra cash each month.

Disadvantage: If you mess up, you lose your house

Student loan interest is unsecured debt.  If you default on your student loans, your lender cannot take your diploma back.

Mortgage loans are secured loans.  If you cannot pay your mortgage, the bank can take your house.

A cash-out refinance means a larger mortgage balance.  More mortgage debt usually means it will be harder to pay off the loan.  When the roof over your head is on the line, things become much more risky.

Advantage: Your Debt Becomes Tax Deductible

Suppose you have $30,000 in student loan debt and via a cash-out refinance, you are able to pay off all the debt.  The $30,000 of student loan debt is now replaced with $30,000 of mortgage debt.

The advantage of shifting debt from a student loan to mortgage debt comes in the tax consideration.  Student loan interest is deductible on your taxes, but it is limited.  Mortgage interest deductions are not subject to the income or interest limits.

Not only do you get lower interest rates with a mortgage, but you also get a much better tax deduction on the interest.

Disadvantage: Large transaction costs

Refinancing your home is not like opening a new checking account.  The process costs thousands of dollars.  Your house usually needs to be appraised.  There are escrow fees and mortgage fees.

Depending upon your student loan balances and interest rates, any potential gains from a cash-out refinance could be entirely eliminated due to the transaction costs associated with refinancing your house.

Better Option: Refinance your student loans instead of your house

A cash-out mortgage refinance looks good on paper and it might be a better choice than doing nothing.  However, it typically isn’t the best alternative for most people.

The best of both worlds solution is to just refinance your student loans with a student loan refinance company.  This route can lower your interest rate dramatically, doesn’t risk your house, and the transaction is free.  Unlike a house refinance, there are no costs associated with refinancing your student loans.  In fact, many lenders will pay you money to refinance your loans with them.

From an interest rate perspective, many of these lenders offer rates below 3%, meaning the interest rates are lower than the mortgage loan.  The downside is that you don’t get 30 years to pay off the debt.

A final advantage is that the student loan refinance process is much faster and more simple than the home refinance process.  The applications typically take just a few minutes and the documentation process is far less intense than what it is for a home loan.

Bottom Line

There are plenty of reasons to consider a cash-out mortgage refinance to pay off your student loans.  However, it isn’t necessarily the best option to eliminate your student debt.  Before starting the mortgage refinance process, be sure to investigate some student loan refinance lenders to explore potential savings opportunities.  You can still lock in lower interest rates, and you don’t have to worry about additional risk to your home or deal with the mortgage refinance process.