Student loan debt is a struggle for many graduates, leading to creative ways of repayment. Many homeowners with student debt have looked into home equity lines of credit (HELOCs) as a possible solution. But is taking out a HELOC for student loan debt a good idea?
As of 2020, student loan debt has hit a record high of $1.56 trillion spread across over 45 million borrowers in the U.S. A 2019 Cengage study found that most graduates expect to pay off their student loans within six years of graduating; however, in reality, it will take most over 20 years.
With such a long loan lifespan and a high amount of debt, it’s no wonder borrowers are looking for alternative methods to pay off their student loans. In this guide, we’ll walk you through what a HELOC is and help you decide if this line of credit is a good solution for your student loan debt.
What Is a HELOC?
A HELOC is also known as a home equity line of credit. Home equity refers to the amount of equity or value of your home. There are two types of home equity: home equity loans and home equity lines of credit. Typically, both types of financing allow you to borrow up to approximately 85% of your home’s value.
For instance, if your home’s value is $250,000, you’ll be eligible to borrow up to $212,500 through a HELOC.
The key differences between home equity loans and lines of credit are how the funds are disbursed, repaid, and financed. Home equity loans offer the full sum of your loan at once, with predictable monthly payments typically due for repayment 30 days after you receive your funds.
Home equity lines of credit, however, allow borrowers to withdraw only the amount they need and typically only require payments on interest for the first five or 10 years. Your interest rate, however, will typically vary as the market rises and falls, although HELOC rates are typically lower than home equity loan rates.
In short, taking out a HELOC can offer you access to a revolving line of credit you can use to pay down your student debt balance, either all at once or over a period of time.
Pros of Paying Student Loan Debt With a HELOC
While applying for a HELOC won’t help with your overall debt – you’ll still owe money long term – it can make good financial sense in certain situations if you own a home. Here are a few reasons why taking out a HELOC can be a smart way to pay down your student debt.
1. Lower Interest Rates
Many borrowers might decide to take out a HELOC to reduce the interest rate on their debt. Depending on whether you have private or federal loans, you might be able to secure a lower rate on a home equity line of credit than on your existing student loans.
Finding out your qualified interest rate on a home equity line of credit can help you decide if you’ll be able to save on interest in the long run. If you have federal loans, a HELOC might not save you on interest, but it can be a good option for those with private loans.
2. Loan Consolidation
There are many ways to consolidate your student loan debt, but if you’re still paying each lender separately, using your HELOC might be a great way to combine your student loan payments into one lump sum.
This would make payments easier in the long run and allow you to get ahead on interest payments during the interest-only payment period by paying more than the minimum required. Be sure to check with your financial institution to see if early or larger payments are allowed before planning on this.
3. Lower Monthly Payments
If you’re struggling to make your student loan payments or are in between jobs, using your HELOC to pay off this debt might make good financial sense. Since you’ll only be required to pay the interest on your home equity line of credit for the initial draw period (around 10 years), you can make lower monthly payments while working on getting ahead financially.
This can be a good option for those in current financial situations, but it’s important that you maintain on-time payments and have a plan to begin paying back the loan principal once you’re financially secure.
Cons to Paying Student Loan Debt With a HELOC
Paying down your student loan debt with a HELOC might seem like a no-brainer at this point, but there are some extremely important financial implications to consider before making this choice.
Here are some potential cons to consider before deciding to use a HELOC to pay off your student loans.
1. Credit Score May Drop
Depending on your student loan balances, you might find your credit score drops when you use a large portion of your HELOC to pay off your loans. Utilizing a high percentage of any credit line can impact your credit report and cause your score to drop.
2. Tax Benefits Cease
Right now, you might be taking advantage of tax benefits from paying your student loans. Typically, you can deduct the interest paid on your loans during tax season, helping you recoup a small amount of money. However, once you pay off your student loan balance with your HELOC, you’ll no longer be eligible for this tax benefit.
3. The Initial Draw Period Can Be Misleading
During the initial draw period of your home equity line of credit, you’re allowed to pull available funds from your account and are only required to make payments on any interest accrued. While this can be a benefit if you’re facing financial difficulties, it can also be a shock after this period expires, and you’re required to make full payments on the principal and interest.
If you don’t plan, you could find yourself unable to make the minimum payments required on your HELOC.
4. You Could Lose Your Home
The worst-case scenario is, of course, the possibility of losing your home. When you default on your student loans, your credit score can be impacted and, in severe cases, lawsuits can be filed against you. However, when you default on your HELOC, your credit score isn’t the only thing that is likely to be impacted.
A home equity line of credit uses your home as collateral, allowing the creditor to take ownership of your home if you miss payments on your HELOC. That’s why it’s important to make sure you have a solid repayment plan before making any decisions about home equity financing.
CollegeFinance.com Has the Tools to Help You Pay Down Student Debt
Paying down student debt quickly is important to many graduates. While utilizing a HELOC can be a good way to consolidate your loans, lower your interest rates, and streamline payments, it’s not the right option for everyone. Be sure to weigh the pros and cons before making this important decision.
If you decide that a HELOC might not be the best path for you – if you’re not a homeowner or you’d like to explore other loan repayment strategies – CollegeFinance.com can help. We have a robust catalog of resources available to help you understand all of your loan repayment options.
Check out our exhaustive guide on how to repay student loans faster and read through our resources on loan consolidation, refinancing, and figuring out which loans to pay back first.
Need more ideas to pay off your student loans as quickly as possible? Check out these seven creative ways to pay off student debt fast.
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