Deciding how to pay for college tuition for yourself or your child can be stressful. For many, financial aid only covers a portion of college expenses, and parents and students are left deciding on how much to borrow in student loans, which loan is best, and other options to explore.
One way you can consider funding tuition costs is through a home equity line of credit (HELOC). If you own your home, you might be eligible to take out a HELOC, which you can use to pay for tuition and other college-related expenses.
We’ll walk you through everything you need to know about HELOCs and how to use them to fund educational expenses for yourself or a family member.
What Is a HELOC, and How Does It Work?
A HELOC stands for a home equity line of credit. Your home’s equity or value is the basis of this financing. If you’re approved for a HELOC, you’ll typically be able to borrow up to 85% of your home’s value. So, if your home is valued at $200,000, you’ll be able to borrow up to $170,000 with a HELOC.
HELOCs are different from home equity loans in a few ways. First, lines of credit allow you to pull out money as you need it within a certain time (typical draw periods last for around 10 years).
Secondly, HELOCs have variable interest rates, which means they rise and fall as the market fluctuates. Thus, your rate and interest will always be changing. On the plus side, HELOCs typically still have lower rates than home equity loans.
Lastly, HELOCs do not require principal payments on your line of credit during the initial draw period. This means you’ll only be required to pay the interest on your line of credit. Home equity loans, on the other hand, require monthly payments after you receive your funds. After your HELOC draw period ends, you’ll start making monthly payments on the principal and interest.
How Do You Get a HELOC?
If you want to look into using a HELOC to pay for college costs, you’ll need to be a homeowner who is in good standing on your mortgage. This means your mortgage payments should be up to date and paid in full. From there, you’ll need to get approved first. You can do this in several ways. First, you can apply through the same lender who handles your home’s mortgage. You might receive a rate discount by bundling services. You can also reach out to your bank or credit union or look for an online lender to start comparing rates.
From there, you’ll need to fill out a HELOC application through your lender. While all financial institutions have their own requirements, here are a few general requirements for HELOC approval:
- A credit score of 650+. Your credit score assesses how you handle and manage your debt and is used to decide if you’re a creditworthy borrower. It’s possible to get approved with a lower credit score, but you’ll need to check with your lender to understand their specific requirements.
- At least 15% LTV in your home equity. To figure out your home equity, you’ll need to know your home’s current appraised value and the amount you owe on your mortgage. For instance, if your home is appraised at $250,000, and you owe $50,000 on your home loan, your home equity would be the balance, or $200,000. To determine your LTV (loan-to-value ratio), you’ll need to divide the balance owed on your mortgage by your home’s value ($50,000 divided by $250,000). In this case, your LTV would be 20%.
- A debt-to-income ratio (DTI) of 43% or lower. This ratio looks at your monthly home expenses divided by the amount of money you have coming in each month. This number helps lenders understand if you make enough money to pay off your current debt. If you pay $1,500 in home costs every month and bring in $6,000, your DTI would be 25% ($1,500 divided by $6,000).
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I’m Approved for a HELOC. Now What?
Once you apply and are approved for a HELOC, you might wonder how you get your funds, how soon you can use them, and how to get them to the school to cover tuition for yourself or your child.
Since a HELOC is a line of credit, funds will be available to pull from during your initial draw period. This allows you only to take out what is needed, so you can pay the school each semester and only owe interest on the money you touch. So, even if you think you’ll need to pay $10,000 each school year, if your child receives additional funding or work-study options, you can stop withdrawing from your HELOC, and you’ll only need to pay back the amount you took out.
You’ll be able to withdraw funds to cover tuition, housing, and other educational expenses when needed.
Pros and Cons to Using a HELOC to Pay for College
While a HELOC might be a good option for your family’s educational costs, you’ll want to weigh the benefits and drawbacks to see if it’s the best fit for your family.
A few pros to consider include:
- The ability to only borrow what you need. If you only have to withdraw $20,000, that’s the amount you’ll pay back.
- Better interest rates. If you’re taking out a HELOC for your child, you might be able to get better interest rates than they can with private student loans.
- Lower initial monthly payments. During your initial draw period, you’re only required to pay back the interest on your HELOC. This allows you more time to save to pay off this loan once the principal is due.
A few cons to consider include:
- Credit score implications. The more you withdraw from your HELOC, the higher your utilization rate. Heavy credit utilization can impact your credit report, which could cause your score to drop.
- Unpredictable interest rates. Although HELOCs tend to have low interest rates, they can be unpredictable if the market isn’t stable. While this may not cost you more in the long run, it can be hard to plan for your next payment.
- Risk of losing your home. Since your home is used as collateral when taking out a HELOC, you run the risk of losing your house if you’re unable to make payments on the interest or principal once it’s due. If your financial situation isn’t stable, and you don’t feel comfortable making monthly loan payments, you might not want to risk having your home taken from you.
Let CollegeFinance.com Help You Afford Tuition Expenses
Paying for college is a challenge just about every student and their families face. Nearly 19 million students applied for financial aid between 2017 and 2018, and for many, their financial aid packages weren’t enough. A HELOC is an option many parents and home-owning students can consider to cover extra costs.
If you’re worried that taking out a HELOC may not be the best choice for your family, however, there are other options to explore. CollegeFinance.com can walk you through all of your financial aid options, including:
We can also walk you through how to appeal your financial aid award to ensure your tuition aid is maximized.
Do you need more help figuring out all the ways you can pay for college? Check out our guide on paying for college without financial aid to learn some creative ways to fund your tuition costs.