For individuals without the savings to cover the astronomical cost of college these days, tapping into home equity via a home equity loan is a very attractive option. However, the most appealing choice isn’t always the best one for your overall financial well-being.
- Home equity loans can have lower interest rates than student loans but carry high risks.
- If you can’t make payments on your home equity loan, you could face foreclosure.
- Saving for college (if you have time to do so), scholarships, and cheaper schools should all be considered before taking out a home equity loan.
Pros and Cons of Using a Home Equity Loan to Pay for College
Compared to student loans, home equity loans can have lower interest rates, saving you money over the course of the loan. If you’re a parent who wants to provide for your child’s education, a home equity loan may be the only way for you to come up with the large lump sum needed for a semester’s tuition.
If you are using the equity that you have in your home to pay for someone else’s education, you are taking on debt to pay for an education that someone else may not finish. If your financial situation changes, you could lose your home for a college degree that someone else may not even attain. Thanasi Panagiotakopoulos, a certified financial planner and founder of LifeManaged, views using home equity to pay for college as a last resort. Clients with college-age children are typically in their last phase of accumulation and “do not have time to take on new debts heading into retirement,” according to Panagiotakopoulos.
Alternatives to Using a Home Equity Loan to Pay for College
Paying for college can be tricky, especially with today’s extremely high costs. If you still have time before you need to pay for college, starting a 529 plan now and putting as much away as possible can put you in a better spot by the time the first tuition bill is due. The potential student may want to consider going to a more affordable school, getting their general education requirements through a cheaper community college first, and applying for every scholarship opportunity available.
If you are about to become an empty nester, then selling your home, downsizing to something smaller, and using some of the proceeds to pay for college can be a way to leverage your home’s equity without taking on additional debt.
While student loans can have shockingly high interest rates, they typically don’t become due for payment until six months after the student has graduated—and some loans, such as subsidized federal direct loans, don’t accrue interest during that time. While your student is still in school, you can start paying on their loans if you want to help them pay for college but don’t have the means to do it up front. Payments made while they are still in school will be applied directly to the principal and will help them pay off their loans faster after graduation.
What is a home equity loan?
A home equity loan is a loan for a fixed amount that uses the equity you have in your home as collateral for the loan. The loan has fixed monthly payments, typically with a fixed interest rate over a specified period of time. If you can’t pay your loan back, then you could lose your home to foreclosure.
Are home equity loans expensive?
Home equity loans are typically cheaper than unsecured debt, such as a personal loan or credit card, because they are secured by using the equity you have in your home as collateral.
Are home equity loans viewed as assets for the Free Application for Federal Student Aid (FAFSA)?
The Free Application for Federal Student Aid (FAFSA) does not count equity in your home against you, but once you take that equity out through a home equity loan, it will consider the money that you received through your loan as an asset offset by the debt of the loan. In addition to FAFSA, many individual schools have financial aid programs that may or may not consider equity in your primary residence when considering aid eligibility. Check with your school for specific rules.
Should you co-sign student loans?
Co-signing someone else’s student loans is risky and should be considered only as a last resort. Under current laws, student loans can be difficult to discharge through bankruptcy. If you co-sign on loans for someone who becomes unable to pay them back, then you’ll be on the hook for them.
The Bottom Line
Paying for college has become astronomically unaffordable over recent years at the same time that home equity has skyrocketed. Taking out a home equity loan to pay for college can be an attractive option, but consider the risks—namely, that you could lose your home to foreclosure if you can’t keep up with payments before signing up for the loan. There are many ways to make college more affordable, so be sure to exhaust all options before taking out a home equity loan to pay for it.