How to Use Your Equity Loan to Pay for College

Posted August 10 2016
by PenFed Team
Father and son packing up car for college

No matter how old your child, it’s never too early to start thinking about how you’ll pay for college: because the sooner you start planning, the easier it will be to manage when the time comes. While building savings over the years is one of the best ways to handle college costs, it can be tough to save—and you definitely don’t want to drain your emergency fund. But if those college bills are looming, you may have an option other than a high-interest student loan: the equity in your home.

Why Use Your Home Equity to Pay for College?

Lower interest rates. Though there are a lot of variables that determine the interest rate you get—including how good your credit is, how long you’re taking out the loan for, and how much equity you have in your house—interest rates on equity loans are typically less than interest rates on student loans.

More payment options. There are several different ways to tap into your home equity: a loan that pays a lump sum amount, a line of credit that lets you borrow as much as you need when you need it, and even interest only lines of credit to keep monthly payments down. This allows you to pick a payment option that best fits your financial needs.

Easier planning. You don’t know much your child will make after graduation, which makes it difficult to determine how much of a loan might be affordable. However, your income is likely more predictable which can help make a firm financial plan.

Tax benefits. You can deduct a certain amount of interest for both student loans and home equity loans, but a home equity loan can be a better option, tax-wise, for some borrowers. Consult a financial advisor to see if one is better than the other.

What Should You Consider Before Taking out a Home Equity Loan?

How much will school cost? The first step will be deciding how much you’ll need to borrow to cover tuition, books, living expenses, and any other college costs that may come up. Once you have an estimate of how much you need, figure out how much you’ll need to borrow to afford it.

How much equity do you have on your home? When issuing your loan, lenders will consider your loan-to-value ratio (LTV), which is the amount you owe compared to the value of the home. If you don’t have much equity, you can expect higher interest rates which may make traditional student loans more appealing.

Can you afford it? If the loan payments don’t work with your financial situation, it may be a bad idea to borrow against your equity because your home is being used as collateral for the loan.

How will it affect your retirement? You can’t neglect your own financial needs because your child is going off to college. Make sure to consider how repaying an equity loan would fit into your retirement plans before you make the decision.

Are there less expensive school options? If you just can’t make the numbers work, it’s time to consider how you can cut college costs (would a community college be a better option?), increase income (perhaps your child could work part time and go to school part time), or combine an equity loan with traditional student loans.

What Are My Equity Loan Options?

If you’ve decided that tapping into your equity is the best option for your financial situation, your big choice is a home equity loan or a home equity line of credit. With a loan have a fixed sum up-front which you pay back at a fixed interest rate. The predictability of a home equity loan can make it easy to work into your monthly budget.

However, a home equity line of credit (HELOC) offers more flexibility. With a line of credit you’re approved for a certain amount and you can borrow as much or as little as you need when you need it. This can be a good option for expenses like school where exact costs can vary depending on the number of hours your child is signed up for and the supplies needed for the semester. With a HELOC, you only borrow—and pay interest on—as much money as you need. However, HELOCs have interest rates that vary depending on the prime rate. A variable interest rate isn’t necessarily a bad thing, but can make your repayment plan less predictable.

Regardless of which home equity option you chose, PenFed has a loan option that will work for you.