Mortgage: Is It a Smart Way to Pay for College? Part 2

The time has come for your student to start thinking about colleges, which means it’s time to think about how they are going to pay for it. Many parents look to their home equity as a possible source of funds to pay for college. Last week, we went over the questions you should ask yourself before considering taking on parental debt to fund  your student’s college education. This week we look at how cash out mortgages and home equity loans work for those parents who are committed to borrow, and are looking for the most preferred debt.

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:

1. 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.
2. Income. No-doc loans are no longer available, so your current income will have an important impact on how high of a mortgage you will qualify for.
   
3. Terms. During the college years, your income is likely to be tight, so consider a longer loan term such as a 30-year loan instead of 15-year loan.
   
4. 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 when the interest rate offered for your refinanced mortgage is lower than your current rate and you do not want to take the interest rate 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. The timing of a cash out is critical to the strategy.

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.

There are a few major 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 then 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 can be 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, make sure you can fully support your retirement and that you take advantage of all available sources of college funding before committing to any strategy.

Westface College Planning can help you build a college funding plan and 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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