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Decide to use the equity in the house to pay for college
January 10, 2023
Verified by
Quinanna Patterson
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If you are preparing to send a child to college, the cost may seem excessive. A home equity line of credit (HELOC) or home equity loan might help you pay for it, but before you can tap into your equity, there are a number of factors to consider.
Key statistics on the cost of college and housing
- The average annual cost of a public university is $10,740, according to the College Board. In comparison, the annual cost of a non-state public university is $27,560. Private colleges and universities cost about $38,000 per year.
- According to Black Knight, in April 2022, the average homeowner had $207,000 in equity.
- According to CoreLogic, the average homeowner earned $64,000 in equity between the first quarter of 2021 and the first quarter of 2022.
- According to TransUnion, HELOC underwriting increased by 31 percent at the end of 2021 compared to the end of 2020, and new home equity mortgage underwriting increased by 13 percent.
What is home equity and how is it used?
Home equity is the difference between the value of your home and your mortgage debt. For example, if you had $170,000 in mortgage debt left and your home was worth $400,000, you would have $230,000 in home equity.
Homeowners accumulate equity by paying their mortgage payments and when the value of their property increases. The increase in equity has been significant due to the booming housing market: in fact, according to the Federal Reserve, the collective equity in U.S. homes recently reached a record $27.8 trillion.
Homeowners draw on their net worth to meet a number of major expenses, including renovation projects, large medical bills, and higher education expenses.
When you use the equity in your home to pay for college, you may qualify for a home equity loan, a kind of second mortgage that provides a lump sum to be used to pay for tuition, room, board and any other costs. The loan is repaid in monthly installments at a fixed interest rate for a set period of time, sometimes as long as 30 years.
Instead of a home loan, you can choose a HELOC, which works more like a credit card. The rates on HELOCs are variable and you can access the money when you need it. A HELOC may be more appropriate for some of the small college expenses, such as books, food and other everyday expenses.
HELOCs and home equity loans versus student loans.
While you can access the equity in your home for any purpose, student loans are used only to cover the costs of earning a degree.
Student loans can come from federal or private sources. Private loans can have very high rates, while federal loan programs offer lower fixed rates. The loan can be in the name of the student or the parent.
HELOC and home equity loans have the disadvantage of putting your home at risk. The other disadvantage: You will not be able to deduct the interest from your taxes if you use the funds to pay for college. However, both options have advantages, including more repayment options and the ability to qualify even with bad credit.
The advantages of student loans
- HELOC loans and home equity loans
- Possibility of debt forgiveness for some borrowers.
- Ability to deduct up to $2,500 in interest per year.
Disadvantages of student loans.
- Can have excessively high interest rates
- May delay other financial goals (such as buying a home) because of debt.
- Repayment options apply only to certain borrowers.
Advantages of HELOCs and home equity loans.
- More flexibility with a HELOC (borrow only what you need).
- Can often be approved even if you have bad credit.
- Ability to choose from a variety of repayment options
Disadvantages of HELOCs and home equity loans.
- The home is collateral
- Not tax-deductible (unless it is a home equity loan used for certain renovations).
- Limited borrowing capacity; most lenders require you to keep 20 percent of the home equity.
Should I use the equity in my home to pay for college?
There is no single answer to the question of whether a mortgage loan is the right choice to cover college costs. You need to think about how much you need, how comfortable you are with taking on additional debt, what your plans are for the future, and how much a home equity loan would cost compared to other financing options. Ask yourself:
What are the student loan options?
There are two types of student loans: federal student loans, which involve borrowing from the government and make up the majority of all student loans, and private student loans, which come from for-profit institutions. Federal student loans have fixed interest rates that are lower for undergraduates and higher for parents and graduate students. Private student loans can have a range of fixed or variable interest rates. Students rarely have much credit, so if your children take out a loan without your co-signer, their rate may be much closer to that of credit cards. Repaying this loan can be much more difficult than writing a thesis or taking final exams.
What are the current rates for home equity loans?
Although rates for HELOCs and home equity loans have historically been lower (lenders are willing to offer better terms since the home is pledged as collateral), they have risen rapidly, almost at the same rate as current student loan rates. For a similar financing cost, it may make more sense to opt for a student loan at this time.
Are you nearing retirement?
Taking out a loan to pay for a child's education is not just about his or her future; you also need to think about the big picture. If you are nearing the end of your working period, you will need to focus on your budget to ensure that you can pay off your debt (whether a mortgage or student loan) and at the same time cover your expenses.
How much college tuition do you need to cover?
If you have more than one child going to college, one mortgage loan may not be enough to cover tuition, room and board for both children, unless you own a very expensive home and have significant equity. You may need to take out several loans, either a home mortgage or a student loan, to pay for everything.
How does your student's future look?
It may be too early to tell what your child will do after graduation, but if he or she already has a clear career plan, he or she may be eligible for student loan forgiveness in the future. Teachers, civil servants, and employees of some nonprofit organizations can have some of their outstanding debt forgiven after a certain period. In contrast, with a home loan, you will have to repay every single dollar.
Should you take advantage of this opportunity to help your child grow up?
When your children enter college, it can be a good time to help them understand what it takes to invest in their higher education. By taking out a traditional student loan in their name, you could instill a deeper sense of responsibility and ask them to attend classes, take an internship and find a good job to pay back all that money.
Risks of a college loan.
- You are putting your home at risk. When you take out a mortgage to purchase a home, your home is put up as collateral. If you get into trouble and cannot afford to pay the installments, the mortgage lender may foreclose on your home.
- The value of your property may decrease. Losing the value of your home may seem impossible right now, but prices do not always follow the rapid upward trajectory we have seen in recent years. (If the value of your home falls significantly, you may end up with debt that exceeds its value.
- You are increasing your debt. Taking on more debt can put a strain on your finances and increase your stress. You need to make sure that you can sleep soundly at night knowing that your bills are increasing.
How to use home equity for college
If you think tapping into your home equity is the right move, here's how to get started:
- Estimate your home equity. The value of your home is not the amount you initially paid. In the past two years, house prices have been rising rapidly. Estimate the value of your home to get an idea of how much equity you really have.
- Know your credit rating (and take steps to improve it, if necessary). If you manage to get a home loan with bad credit, you will not be able to take advantage of lower rates. Check your credit rating before you apply. Most lenders reserve the best loan terms for borrowers with a score of 740 or higher.
- Compare lenders. Consider at least three home equity lenders and compare rates, fees, terms, maximum loan amounts, credit requirements, etc. Consider other features you may need later, such as the ability to convert an adjustable-rate HELOC to a fixed-rate home equity loan.
Alternatives to using equity for education
Putting your home equity at risk to pay for your education can be risky. If using equity does not seem like the right choice, consider these alternatives for finding the funds you need.
- Grants and scholarships- While your child is applying to college, have him or her apply for grants and scholarships. Many universities offer merit-based scholarships that reward academic achievement, but there are other financial aid options as well. Some scholarships are small, as little as $500, but they can cover the entire bill. Discover's scholarship tool includes more than three million scholarships for every type of student.
- Financial Aid - Be sure to fill out the FAFSA (Free Application for Federal Student Aid), which can help your student get financial aid based on your income.
- Work study programs - Supervising the computer lab, grading papers, arranging campus visits - many universities offer work study positions to students who qualify for financial aid. Students will earn at least the federal minimum wage (and in some cases much more), and the money can help cover some of the university's expenses.
- Payment Plans - Many institutions offer monthly payment plans, which can be easier to manage than handing over a large check at the beginning of the semester.
Conclusion
Using a HELOC or home loan to pay for college is not for everyone. While they have their advantages, loans against the home are becoming increasingly expensive due to rising interest rates. Remember to compare the monthly payments of a home equity loan with those of a student loan. Remember that a HELOC, which can have a particularly low introductory interest rate for 12 or 24 months, can be useful for small expenses such as paying for books and supplies. If you decide to dip into your home equity to pay for your child's education, it is essential to make sure your child understands what it means for you as a parent to take on more debt. They may leave home, but you will stay. So they need to understand that your investment is worth it.
