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Retire student loans with home equity--not
Question: I have an adjustable rate mortgage with a principal of $255,000; I'm going to refinance to a fixed rate this month and I expect a rate between 4 and 5%. I also have student loans of $35,000 with an interest rate of 6.25%.
Is there any reason not to take enough cash out to pay off my student loans? It seems like an obvious decision, but I want to make sure that I'm not overlooking anything. Thank you! Kristina, San Francisco, CA
Answer: I would not take money out of your home equity to pay off your student loans. It's a risky strategy to save a percentage point or two on your loan. (I am assuming these are federal student loans.)
The big advantage of keeping the federal student loans is financial flexibility. Let's say you get into a financial bind. Maybe you lose your job or confront a medical emergency. You have a number of options to buy yourself financial relief with the student loans.
For instance, with economic hardship you can apply to suspend repayments for up to three years. Another option is to slash your monthly tab by shifting to the income-based repayment plan. Most borrowers have a monthly payment of less than 10% of gross income with the income-based loan. (You can learn more about income-based repayment here.)
However, you lose the financial flexibility embedded in the debt obligation once it's turned into a mortgage payment. Mortgage companies don't care about economic hardship. Forget deferment or forebearance, let alone an income-based repayment plan. No, can't pay the bill? They'll foreclose on you. This scenario has happened to far too many people ever since the real estate market went bust.
Now, there is a case for your strategy if these are "private" student loans. The term is really a misnomer. These are consumer installment loans with a different label. The private lenders offer none of the built-in flexibility of federal student loans. You can't discharge private student loans in bankruptcy, either. (The same holds for federal student loans.)
Still, if they're private student loans and you decide to pay them off with home equity I would make sure you have a hefty cash cushion left over to withstand any setbacks. However, I remain wary of tapping into home equity to even payoff private student loans. I'd rather you preserve the equity and devise a plan for attacking the student loan debt more aggressively. It's a safer way to save on interest costs.
I agree that this analysis is incomplete. Two other considerations.
First, depending on income level, Kristina may not qualify for the income tax deduction for student loan interest. She will be able to deduct it as mortgage interest.
Second, if Kristina includes this debt into a 30 year mortgage, she'll pay a lot more interest over time even though the rate itself is lower. The way I would recommend doing it is not by including the student loan debt in the mortgage, but financing it through a home equity line. That way, she gets a lower interest rate, the deduction, and she can pay that off more quickly. If interest rates increase, she can convert to a home equity loan to lock in the interest rate.
The writer obviously has never taken out a student loan. A few things:
Student loan debt has zero consumer protections that other debts possess. Examples: Student loans have no statute of limitations on collections and no bankruptcy alternative. Additionally, the federal deferment and forbearance options capitalize the interest. These are not helpful to the borrower who may have to forbear or defer. Additionally, the student loan companies can come after a person without a judgment, collection fees are added on at will, wages can be garnished....including but not limited to social security and tax returns. The loans I speak of are just the federal loans!!! Private loans are much worse.
Also, the IBR program can lead to financial disaster because if the borrower gets a raise they can be kicked out of the IBR program. The "waived" debt then capitalizes and becomes due. Is there a tax bill at the end of the term? Under current law the relieved debt is taxable income in the last year.
It is this kind of ignorance perpetrated by the writer that causes people to get into financial trouble. Do your research sir before advising others. Student loans (both private and federal) are predatory.
Kristina...my advice to you: if you have equity in your home that is large enough to pay off your student loans, do it. Do it yesterday.
My beef with student loans is that even when you are ahead in your payment schedule, you cannot pay a chunk toward principle (as you can with a home or car). It gets assigned to "future payments" (interest AND principle). I am contemplating a home equity line to payoff the $24k I owe in 5 yrs for just a slightly higher premium than I am paying to the fed student loan. 3.45 % vs 5.6 % -- with the opportunity to pay down principle ahead of schedule when I receive a chunk of income above and beyond my normal budgeting. Yes, I hear you on the risk of future unforseen events, but the savings could be pretty massive. Haven't pulled the trigger yet, but I am getting close.
