One of the more creative ways to knock out student debt is to take out a Home Equity Line of Credit and use the proceeds to pay off student loans. Essentially, as a borrower, you are paying off one form of debt (student loans) by adding another (a second house payment). For those unfamiliar with the term HELOC, it is essentially a second mortgage on a house.
This approach can be used by homeowners who want to take advantage of low mortgage rates as a tool to pay down student debt.
This financial move has its perks, but there are also significant risks associated with going this route.
Home Equity Line of Credit Advantages
The primary advantage of going this route is locking down lower interest rates. With student loan interest rates often in the 6 to 8% range, and at times double digits, the much lower interest rates associated with a home loan can result in huge savings.
Additionally, many HELOC borrowers can deduct the interest on their taxes, resulting in further savings. While there is also a student loan interest deduction, its income limits and deduction cap limit the potential savings for many borrowers. Having additional tax savings makes the HELOC interest rate effectively lower.
A Similar Option:Borrowers interested in using home equity to pay off a home should also consider doing a cash-out refinance. It comes with many of the same advantages and disadvantages of a HELOC but can often come with lower interest rates.
The HELOC Disadvantage
The problem with borrowing money via a HELOC is that the debt is secured by your house. This means that a failure to pay back the debt results in losing your home. While there are severe consequences for failing to pay off student loans, they do not compare to foreclosure. Regardless of how strong your financial situation is at present, this risk makes the HELOC option very dangerous.
A Less Risky Alternative
If your choices were to either pay off your student loans via HELOC or live with high interest rates, the decision might be difficult. However, there are other options out there that are much better for most borrowers. The best alternative for many is refinancing or consolidating with a private lender. This area of lending has gotten especially competitive over the past few years, and there are now more about a dozen lenders offering this service.
Borrowers who go the refi route can secure interest rates below 2%, which could potentially be less than the Home Equity Loan. The best part is that the debt is not secured by your house. If you fail to pay, there are still consequences, but you won’t get kicked out of your home.
Using a Home Equity Line of Credit to pay off student loans is a very creative solution, and it does come with real advantages. However, putting your house at risk is something that should be taken very seriously. In most situations, the safest bet is likely to refinance with a new lender to protect your most important financial asset, your home.