Is it a Better Option to Refinance My Home or my Student Loans to Pay off Student Loan Debt?

Across 44 million people in the US, they hold a total of $1.3 trillion dollars in student loan debt. Borrowers everywhere are seeking answers to determine the best way to tackle student loan repayment. For graduates who also happen to be homeowners the questions is; is it in your best interest to refinance your home to pay off your student loans, or is student loan refinancing the better option. The answer, of course, is it depends.

Home loan refinance programs essentially allow borrowers to trade one debt for another (student loan debt for mortgage debt) while student loan refinancing allows borrowers to take out a completely new loan with a different interest rate. The benefits and detriments lay in whether or not your home’s worth supports lender’s requirements, and whether or not you’ll actually be able to secure a lower interest rate.

Should I refinance my student loans?

Putting your house on the line is a serious risk, and while you can refinance your home with a minimum credit score of 620, you’re likely to get a much better rate through student loan refinancing with a higher credit score. Student loan refinancing rates are based on your credit score, so if you have solid credit this could be the safer and better option, and result in substantially lower payments. This option is not available through the federal government, only through private lenders; however, you can refinance your federal loans using a private lender.

Refinancing could be a good option for borrowers with private loans who had limited credit or poor credit when first financing student loans, but have since established more credit history and have a healthy score. A poor credit history or low credit score makes you a high-risk borrower and typically result in higher interest rates, whereas additional history and an increased score could potentially result in a refinance with a lower rate.

For federal loan borrowers, sometimes when you took out your loans could be the deciding factor in whether or not private refinancing is a good option for you. Federal student loan interest rates hit historic lows around 2013, and a refinance offer likely won’t be competitive. However, if you borrowed in preceding years at higher rates, and have excellent credit, you may be able to qualify to refinance at a lower rate.

Before considering student loan refinancing, be aware you will lose certain benefits that accompany federal student loans including Income-Based repayment. However, according to consumerfinance.gov, if you have a secure job, savings for an emergency, a strong credit score and likely won’t benefit from forgiveness based options, it’s worth considering what student loan refinancing can do for you.

Should I refinance my home?

A cash-out refinance is another way to go about combatting debt. It allows you to turn the home equity you’ve built up into cash that you can use for whatever you like. Most people use it to fund large purchases or pay off loans.

As home prices continue to rise, home equity loans are becoming potential sources of cash for homeowners. Although mortgage rates have picked up slightly in the recent months, they still are historically low, with the 30-year fixed-rate average at 3.97 percent. For homeowners that are looking to lower their monthly payment, these low rates make for a great opportunity to refinance. They can also help to get rid of high-interest credit card debt, considering that almost 10 percentage points separate the average credit card interest rate from the average 30-year mortgage rate.

While this could be a very convenient option for some, it’s important to consider a number of factors before making this decision. For older homeowners who have a lot more home equity, this sort of refinancing to pay off student loans might make sense under the right circumstances.  Echoing these sentiments is Rohit Chopra, a senior fellow at Consumer Federation of America: “Borrowers with a lot of home equity can often get mortgage rates that are substantially lower than the rate on their student loan…” New homeowners might not have as much to gain, and are at a greater risk when considering rolling their student loans into mortgage. That being said, no matter who the borrower is, it’s important to thoroughly consider certain factors before choosing to use home equity to pay off student loans.

First, even though your rate may be lower, your home is essentially at risk. Lenders offer a lower interest rate because they have a legal claim to your home if you don’t pay. In the event that you can’t pay, you could end up in foreclosure. While this is inherent in all mortgages, increasing the amount you owe on your home does extend the amount of time your home will be acting as security for your debt.

Second, you are giving up alternative repayment options and forgiveness benefits on federal loans. Federal student loans have varied protections including Income-Based Repayment (IBR). However, when home equity is used to pay off college tuition costs, these benefits no longer exist. It’s also critical to consider the impact refinancing to pay off student loans might have on your taxes. You can claim a maximum of $2,500 in deductions for student loan interest. On the contrary, the mortgage interest deduction has a much higher limit and could equate to a greater tax benefit in cases of high income earners. The $2,500 deduction (which can only fully be claimed if your adjusted gross income is below $65,000) is great for students and recent grads, but may not be of use to those in the workforce whose gross income exceeds this figure. It’s best to consult a tax advisor to consider various options. Be sure to thoroughly research and get answers to these questions if you choose to refinance your loans.

Regardless of the payment or refinancing options you’re considering it’s important to understand what you’d be giving up or gaining in the process and carefully evaluate what you’re financially able to afford.

Sources:

1. www.nytimes.com/2016/11/10/your-money/how-refinancing- your-mortgage-can-pay-off-your-student-loan.html
2. www.interest.com/home-equity/news/4-smart-moves-for-using-home-equity/
3. www.nerdwallet.com/blog/mortgages/refinancing-mortgage-pay-off-debt-right
4. https://www.consumerfinance.gov/about-us/blog/should-i-use-a-home-equity-loan-to-refinance-my-student-loans/
5. www.washingtonpost.com/news/grade-point/wp/2017/04/27/should-you-use-home-equity-to-pay-off-student-loans
6. www.forbes.com/sites/tomanderson/2016/01/18/how-much-the-student-loan-interest-deduction-really-saves-you
7. www.housingwire.com/articles/38430-sofi-and-fannie-mae-announce-cash-out-refinance-student-loan-offering
8. www.consumerfinance.gov/about-us/blog/should-i-refinance-my-student-loan