Why HELOCs Are Not the Way to Pay off Student LoansEmail This Article
Thinking about leveraging the equity in your home by using a HELOC to pay off your student loan debt? Think again. There are several reasons you should reconsider this strategy. A Home Equity Line of Credit (HELOC - or sometimes referred to as just HEL) allows you to borrow against the value of your home. While that may sound promising, there are a number of considerations at play, including what you could be giving up in student loan benefits. Here’s our take on the top factors you should keep in mind.
It’s still a mortgage
Simply put, HELOCs are mortgages. And whether we’re talking about a first or second mortgage, there is a lien on the property. If you begin having difficulty making your payments, your home will be at risk. This could happen with either the first or second mortgage, or both. At the end of the day, taking on a new line of credit against your home to repay student loans means you just transfer your obligation(s) from one entity to another. Don’t be seduced by the advertised low rates (more on that in a moment). Ultimately, a HELOC is an asset-backed loan and could be foreclosed upon if your repayment obligations are not met.
Student loans offer hardship assistance
In the case of hardships, you have much more flexibility with federal student loans—and even some private student loans—than you do with mortgages. Think deferment, forbearance, Income-Driven Repayment Plans, consolidation (and the possibility of student loan forgiveness for qualifying programs.) Some private lenders also have programs in place to help you through short-term financial hardships, and many offer private student loan consolidation and refinancing options with better terms than a HELOC (and you won’t be putting your home on the line).
When was the last time you called your mortgage holder and told them you needed a break from payments for six months because of financial difficulty? Yeah, you get the point. Mortgages need to be paid every month. Period. Borrower protections, flexible repayment plans, and loan forgiveness are not perks you will find with HELOCs.
The "L" in HELOC stands for line, not loan
A HELOC is not a loan, it is a line of credit. And unlike home equity loans, HELOCs typically have variable interest rates which can change over the life of the line. Some banks may offer a fixed rate but you usually must meet specific criteria, such as borrowing a targeted dollar amount. It is possible to take out a HELOC and convert a portion of it into a fixed-rate advance. In most cases, this happens under a blended or hybrid option where there is a fixed rate and fixed term for one portion of the line. The tradeoff is the interest rate you pay is often higher than a variable rate you would pay under a traditional HELOC. A variable interest rate means your payments may change, and if money is tight, this might push your payments beyond what you can afford.
Wait! My payments might change?
HELOC rates are tied to the Prime Rate. The rate you receive on a HELOC will generally re-adjust when/if the Prime Rate changes, meaning there is some unpredictability regarding interest rate changes. But what could be most alarming is banks may offer an introductory rate (much like credit cards) then raise your rate over the life of the line of credit. And while HELOCs do impose rate caps over the lifetime of the line, they do not have the same periodic interest rate caps that adjustable rate mortgages (ARMs) offer. Therefore, your rate could balloon pretty dramatically - by as much as close to 20% in certain states.
You could be throwing away free money
Remember our second point about student loan hardship assistance and the potential for loan forgiveness? Well, federal student loan forgiveness is worthy of a repeat mention. If you were to convert your student loan debt to a HELOC, you are giving up any benefits you may have otherwise been entitled to receive under that student loan program. But here is another consideration: a number of employers are now offering benefits that include student loan repayment assistance. This is a trend that is expected to grow in 2017. If you no longer have a qualifying student loan, that could translate to leaving free money on the table – twice!