With a fluctuating economy, dwindling stock market returns, and stagnant home values, paying for college can understandably be overwhelming. So it’s no wonder some parents are looking into using their home equity to help their student pay for college. But is taking equity out of your home in the form of a new home loan or refinance the most optimal financial strategy? There is a lot to consider when debating where the funds should come from in order to pay for college. Using the equity on your home may not be the best move for everyone.
Before setting out and using your mortgage to fund college, you should determine your financial goals. Remember all debt creates an obligation on future earnings.
Here are a few key questions to ask yourself:
- When do I want to retire?
- Do I have enough money saved and expected in future earning power to fund my retirement?
- As a parent, how much can I afford to contribute toward my student’s education?
- How much of a sacrifice of my retirement am I willing to take for the sake of my student?
Now, look at yourself in the mirror. Do you have enough to be financially stable? Can you afford to help your student pay for college? I t can be difficult, but parents need to put their financial well being ahead of paying for a student’s college. They can always take a year off to save or use student loans to pay for college, but there are no loans for retirement. If you don’t save enough for retirement, you will not only be hurting yourself, but you also could put your student in a situation where they may have to help support you financially later on in life.
On the other hand, borrowing money via a mortgage at today’s historically low interest rates may be the best answer for you.
Getting a cash out mortgage refinance allows you to refinance your existing mortgage for more than you currently owe and cash out any extra money that is left over. Typically, homeowners are allowed to refinance up to 80% of their property’s value.
Here are four factors to consider:
- Equity. Some homeowners have built up sizeable equity, particularly in recent years as home values have started to rebound, but some do not have much. The more equity you have, the more cash is available to you through a refinance.
- Income. No-doc loans are no longer available, so your current income will have an important impact on how high of a mortgage for which you will qualify.
- Terms. During the college years, your income is likely to be tight, so take into account a longer loan term such as a 30-year loan instead of 15-year loan.
- Interest rates. Depending on the age of your existing mortgage, a refinance might lock you into a lower interest rate than you were previously paying. If rates are higher, consider the tax benefits of the interest that you pay on your mortgage when deciding what you can afford to borrow.
Cash out mortgage refinance is typically the best option. This is true when the interest rate offered for your refinanced mortgage is lower than your current rate and you want to avoid the inevitable risk that comes with a home equity line of credit.
The major drawback to cashing out a lump sum of cash in a home refinance is that the new available cash will count as a parent asset on the FAFSA and CSS Profile. Critical strategy lies in the timing of a cash out.
For flexibility, a home equity line of credit is very tempting. You can tap into it as needed to pay for tuition, as well as other expenses, and only pay interest on the amounts advanced.
Concurrently, there are a couple glaringly negative drawbacks when it comes to using a home equity line of credit:
- First, mortgage lenders can shut down credit lines if home values drop. If that happens, you can say goodbye to that money.
- Second, home equity line of credit come with variable interest rates, meaning 10 years from now, education could prove very expensive if rates increase. That said, a fixed-rate second mortgage delivers the entire amount in one lump sum, and you must begin to pay it off right away, but over 30 years. Your lump sum can’t be cut and your payment is attached to a fixed rate.
While re-finance and home equity loan interest rates can be favorable and the tax treatments tempting, putting your future at risk to fund a student’s education may not be the wisest choice for your financial health. In addition, many student loans offer benefits that home equity loans don’t. For example, student loans can be deferred in times of financial difficulty while home equity loans cannot.
These options can be valuable parts of your college funding strategy, but make sure to do your research. Don’t put your future at risk, be absolutely certain you can fully support your retirement, and take advantage of all available sources of college funding before committing to any single or multifaceted strategy.
Westface College Planning can help you navigate the college planning process from start to finish. To learn how we can help you call us at (650) 587-1559 or sign up for one of our Tackling the Runaway Costs of College Workshops or Webinars.
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