Homeowners

Using Your Home to Pay Off Your Student Debt: Here’s What to Know

Now that federal student loan payments have resumed, many people across the country are feeling weighed down by their outstanding balances. But homeowners may have options to help them pay off their student debt.

Current estimates show that around 42.7 million borrowers currently owe more than $1.6 trillion in student debt, according to the U.S. Department of Education.  And some of these loans have higher interest rates than mortgages.

That’s why an increasing number of homeowners are turning to their properties. They may be able to tap into their equity to pay off their loans with reduced fees with new kinds of cash-out refinances.

“Many borrowers are sitting on a lot of home equity, which can be used to pay off thousands of dollars of student loans,” said Kathleen Gubbels, AVP of product development with New American Funding. “[This] gives them the ability to significantly reduce their overall student loan debt.”

How do cash-out refinances for student debt work?

Using a cash-out refinance to pay down student loan debt works by tapping into home equity. Homeowners will take out a new mortgage that’s larger than their existing one. Typically, the difference, or at least a portion of it, is used to pay off student loans. And the new mortgage, which replaces the previous one, is paid off every month.

(Home equity is how much of the property that the homeowner owns outright. This amount depends on the size of the down payment, how much of the loan principal has been paid down, and if property values have increased.)

The loans are backed by Fannie Mae. And they offer lower costs than traditional cash-out refinances, where the buyer usually pockets the extra cash.

One caveat, however, is these loans require at least one student loan to be paid off at closing, in full. In these cases, the proceeds are paid directly to the student loan servicer as part of the closing process, rather than directly to the borrower.

“The student loan cash-out refinance option gives borrowers the ability to pay off some, if not all, of those student loans by paying the proceeds of the cash-out refinance directly to the student loan servicer at closing,” said Gubbels.

What homeowners should know about student loan refinances

These cash-out refinances can be used to pay off an array of student loans, from federal to private. But there is a limit to how much home equity can be put toward the debt, up to 80% of the value of the property.

They can also be more affordable than traditional loans.

“Borrowers who utilize the Fannie Mae student loan cash-out refinance option have the ability to pay off student loans through a refinance without incurring traditional cash-out loan level pricing,” said Gubbels.

For some homeowners, this kind of refinance has the potential to offer lower upfront costs than a standard cash-out refinance used for other purposes.

When it makes sense to refinance your home to pay off student loans 

Using a cash-out refi to pay down student debt may make the most sense for homeowners with high-interest student loan debt. It may be a particularly good option for those with private or federal student loans with interest rates that are higher than their mortgage rates.

These loans may also be appealing to borrowers who have built up a lot of equity in their homes and plan to stay in their homes for the long term. Homebuyers who have seen mortgage rates fall since they bought their homes or last refinanced may also want to explore these loans.

One thing to note, however, is cash-out refinances still have risks.

“When utilizing the student loan cash-out refinance feature, borrowers are essentially re-setting their mortgage term and that could lead to a longer term to pay off,” said Gubbels.

That’s because most homeowners are replacing their existing mortgage, which they may have been paying off for years, and replacing it with a new, longer one.

Homeowners also need to make sure that it makes financial sense to use one of these loans. If the interest rate on their student loans is lower than current mortgage rates or they are replacing a very low interest rate with a much higher one, they may not wind up saving money.

And since borrowers are converting their student loans into debt secured by their home, it’s important to remember that missing payments could put their home at risk.

Another thing to keep in mind is that going this route to refinance student loans could cause some homeowners to forgo some protections like income-driven repayment plans, deferment, or forbearance options, as well as potential loan forgiveness programs.

Refinancing your home to pay off student debt may be a good option

These cash-out refinances may be a powerful tool for homeowners who have built significant equity in their properties but are struggling with high-interest education debt.

It’s important, however, to do your research before jumping to this option to see if this is the right move for you. 

“When utilizing the student loan cash-out refinance feature, borrowers should be aware of their payment and how much [they] can afford to pay each month,” said Gubbels.

Run through the numbers carefully, compare your current student loan costs with your potential new mortgage, and consider how this move could impact your finances both short and long-term. If the math works in your favor, this can be a viable way to relieve some of the pressures of those pesky student loans.