Historically speaking, student loans have been difficult for people to pay off. According to 2024 statistics, the average federal education loan amount owed by students is roughly $38,000 and when private loan debt is factored in, this figure bumps up to close to $41,700.
To pay off student loans, borrowers sometimes turn to Home Equity Lines of Credit (HELOCs) as a financing option. There are pros and cons to this practice. Whether it’s a good decision or not will depend on various factors, such as existing debt (specifically a mortgage) and current interest rates, along with a few other factors.
Understanding how educational loans impact HELOC eligibility is key to making informed financial decisions about home equity and debt management. If you consult with a financial advisor, this can help clarify your options and secure your financial goals.
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What is a HELOC and How Does it Work?
Traditional loans give borrowers a lump sum amount, but home equity loans work differently. A HELOC is a home equity revolving line of credit that allows homeowners to borrow money using the equity of their property as collateral and can be used for various purposes.
Some people opt to use lines of home equity credit to pay off the loans they took out for their child’s education. Students who are financially independent and may have gone on to pursue an advanced degree may take out home equity loans to pay off their previous or current college loans.
Home Equity Lines of Credit (HELOCs) Explained
A HELOC typically comes with a variable rate for interest, and its repayment period may vary; a general rule of thumb is the repayment time is five to 10 years. Homeowners can withdraw funds up to 80% of their home’s value, minus any outstanding mortgage balance. Home equity loans often have closing costs and fees associated with them which borrowers should factor in when weighing their financing options.
In some cases, a home equity line of credit is potentially a good option. However, a HELOC isn’t always the best option to pay off one or more student loans, especially with a variable rate HELOC, and if you have to pay closing costs.
Understanding Student Loans
Students can turn to a variety of lending options when financing their college education, including scholarships, grants, federal and state financial aid, and loans.
Most students pay for some or all of their education with federal loans and private student loans. Pew Research Center indicates 36% of people under 40 years who have attended college and earned at least a 4-year degree have outstanding student debt.
Let’s take a look at both federal student and private student loans.
1. Federal Student Loans
Federal loans for students are offered by the U.S. government’s Department of Education and are designed to help students finance their college, university, or trade school expenses. There are several types:
- Direct Subsidized Loans
- Direct Unsubsidized Loans
- Direct PLUS Loans
- Direct Consolidation Loans
These loans come with fixed interest rates and repayment terms, also offering borrower protections, such as income-driven repayment plans and student loan forgiveness. These will vary from loan to loan type and repayment terms are generally about 10 years.
Benefits include (usually) a lower interest rate and a child’s eligibility isn’t necessarily based on having a credit history or needing a co-signer to be approved. Applicants must complete the Federal Application for Federal Student Aid (FAFSA).
Federal loans used for education are considered a type of debt when applying for home equity loans.
2. Private Student Loans
Private student loans are offered by private lenders, such as banks, credit unions, and online lenders. These loans might have a variable or fixed rate of interest and offer fewer protections for borrowers than federal student loans.
Some borrowers ultimately decide to take this route because they can get access to more borrowing power (higher loan amounts to cover all expenses that student loans may not cover). They may also potentially obtain a lower interest rate if their credit is excellent, along with terms for flexible repayment monthly payments — generally anywhere from five to 20 years — which is appealing for people who either want to a) pay off their loan quickly or b) need extended time to pay off the remaining balance on their financial obligations for their education.
Private student loans are also considered a type of debt when applying for a HELOC.
Strategies for Qualifying for a HELOC with Educational Loans
Before approving borrowers for a home equity loan, they’ll need to qualify. Lenders typically set several eligibility criteria to approve a home equity line of credit. Ask yourself the following questions to determine if you might qualify for a home equity loan to pay for your child’s college education.
- Do you have a good credit history? Lenders usually look for better credit scores, usually 680 or higher, but some lenders may accept scores of 620 or lower. The higher your score, typically the more favorable loan interest rate terms you’ll get.
- What is your debt-to-income ratio (DTI)? Lenders look for DTI to be below 50%
- How much of your home’s equity is available? You must have home equity of at least 15% to 20% and have previously and routinely made payments to your mortgage lender.
- Do you make on time payments for your bills? Lenders look for a solid history of making regular monthly payments to creditors before offering a credit line for home equity.
- How much is your monthly income? Lenders will evaluate your eligibility based on how much you earn.
- How much does the lender expect you to pay for closing costs? If this exceeds other options or is higher than student loan rates, it might not be your best option.
Calculating DTI
You might be wondering how to calculate your DTI. To do this, add up your monthly debt payments (e.g. mortgage/rent, car loan, and any other debt) and divide by your gross monthly income. If you discover your DTI is too high, take steps to reduce it to make your financial standing be more appealing to lenders.
- Pay down existing liabilities, such as credit card debt (try to pay down principal, not just interest payments)
- Begin making payments consistently and timely (avoid missed or late payments)
- Boost your income with a new job, raise, or side hustle
- Avoid applying for new credit cards or other loans
One thing you don’t want to do is slow down paying your debt to save for loan payments. Additionally, before getting a home equity loan to pay for your child’s college education, you’ll need to obtain a home appraisal, so the lender can set a HELOC limit for extending credit.
Working with a knowledgeable financial advisor can provide guidance on how to position yourself to qualify for a home equity loan. Find a financial advisor today!
How Student Loan Debt Affects HELOC Approval
Student loan debt can affect HELOC approval, as lenders heavily consider it when evaluating creditworthiness. For instance, if you have high student education debt, this can negatively impact your credit score and debt-to-income ratio. Additionally, lenders may view student loan debt as a risk factor when approving a HELOC, and may deny the loan application.
Alternatives to Using a HELOC to Pay Off Student Loans
Federal student aid, such as income-driven repayment plans and student loan forgiveness programs, can help borrowers manage their educational debt. Other options include private loans, such as personal loans or credit cards, which can also help pay off student loan debt. Before using a HELOC to pay college education debt, you’ll want to explore all possible options.
HELOC vs. Student Loans: Which is Better?
HELOCs and student loans have different interest rates, repayment terms, and protections for borrowers. This means there is no one-size-fits-all answer to the question of whether a home equity loan or a student loan is better.
1. Using a HELOC to Pay Off Education Loans
Pros and Cons of a HELOC
Benefits often attributed to HELOC loans include the option to consolidate debt, gain access to lower interest rates (when compared with private student loans), and reduce monthly payments.
You can borrow only as much as you need, avoiding paying interest on a larger loan. HELOCs are also dischargeable if the borrower needs to file for bankruptcy. However, if the borrower only needs a single lump sum to cover smaller amounts that scholarships, grants, and federal loans didn’t pay for, it might make more sense to use a HELOC to pay for books, fees, etc.
However, it’s crucial to keep in mind when taking out a home line of credit, you put your home at risk for foreclosure if you default on your HELOC loan. You also cannot take tax deductions for interest paid on HELOCs for student loan purposes. You can only take the deduction if the home equity loan is used for home improvements.
Other disadvantages to consider about a HELOC to pay for college include it having an adverse impact on FAFSA eligibility, offering a higher interest rate (when compared with rates offered on federal student loans), prepayment penalties if you pay everything off before the repayment period end date, and closing costs, which can be expenses.
2. Paying for Higher Education With Student Loans
Pros and Cons of Student Loans
A big advantage of applying for federal or private loans is they help cover major expenses for higher education. They also provide students with a way to borrow money, even if they don’t have a credit history, also helping them to build a good credit score, so long as they continue to make regular payments.
Other benefits include a fixed interest rate, borrower protections, forgiveness programs, and the ability to get a student loan interest deduction on federal taxes, up to IRS-allowed limits. Furthermore, most are fixed-rate loans.
However, student loans can potentially have higher interest rates and monthly payments. Borrowers also cannot discharge their education loans if they file for bankruptcy or may not qualify for enough to cover their tuition and housing expenses with their student loan payments.
Risk Vs. Reward Analysis for Home Equity Loans Vs. Student Loans
When deciding to apply for a home equity loan vs. one or more student education loans, it’s vital to perform a risk vs. reward analysis before determining which financial option is the more feasible one and makes the most financial sense. Since everyone’s financial situation is different, consider your individual circumstances.
- Compare lenders to see which have better terms
- Determine if interest is a fixed or variable rate
- Decide what you can afford for your monthly payment
- Do the math to see if you need a tax deduction for education expenses
Working with a financial advisor can help you identify your best options. In most cases, they can help identify solutions with more favorable interest rate terms, are not home equity loans, and avoid putting your home at risk.
Conclusion
Student education debt is directly linked to whether or not a borrower will be approved for a HELOC loan since education loans are considered a type of debt during the HELOC application process. Borrowers should carefully consider the pros and cons before deciding to use home equity loans to pay off student debt.
Looking at alternative options to pay for education is an essential step to take, especially federal student financial aid, federal loans, and private loans. Additionally, you can explore alternative debt management options, including but not limited to debt consolidation loans, credit counseling, debt settlement, and credit repair strategies.
However, if it appears a HELOC is the loan option making the most economic sense, you can use specific strategies to get your application approved to obtain cash using your home’s equity as collateral. The primary way to do this is by paying down debt, increasing your monthly income, and ensuring a strong credit score.
Consulting with an experienced financial advisor who can provide advice and guide you through your options to help create a sound financial plan is your best bet. A professional advisor can also help you make the best decisions for your long-term financial health.
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