Using home equity to pay off student loans can save you money by lowering your interest rate. But you must be aware of the risks involved before choosing this option. You risk losing your home if you can’t afford to make the payments. You’d also lose federal student loan protections such as disbursement and forbearance. Before using home equity to pay off debt, it’s important to understand the pros and cons.

But first – what is home equity and how can you use it to pay off student loans?

What Is Home Equity?

Home equity refers to the current value of your home minus what you owe on your mortgage.

Let’s say you owe $100,000 on your mortgage loan. And the current value of your home is $150,000. In this case, you have $50,000 of equity in your home. If the current value of your home is $100,000 then you don’t have any equity in your home. Generally, you’ll have higher equity when property prices are up.

Home equity is one of the greatest assets a homeowner can have. You can tap into your equity any time to free up money for other urgent purposes. One of the things you can use it for is to pay off student loans.

2 Ways to Use Your Home Equity to Pay Off Student Loans

There are two ways you can use your home equity to pay off debt:

1. Take a cash-out refinance loan –With this option, you give up your old mortgage and take on a new one. The value of the new mortgage is equal to the old mortgage value plus your home equity value. The lender processes the new loan and gives you cash worth the value of your home equity. You can use the loan proceeds to pay off your student loans. A cash-out refinance loan is a good option if you qualify for a lower interest rate.
2. Take a home equity loan – This option involves taking a loan against your home equity. The home equity acts as collateral for the loan. Doing this allows you to access your home equity while leaving your current mortgage unchanged. A home equity loan may be a better option if you don’t qualify for a lower interest rate.

Advantages Of Using Home Equity to Pay Off Student Loans

1. You may qualify for a lower interest rate

Home mortgages and home equity loans are types of secured loans. Student school loans on the other hand are unsecured loans. Interest rates on secured loans are typically lower than rates on unsecured loans. When you use home equity to pay off student loans, you’re taking on a low-interest loan to pay off a higher-interest loan. This is a smart strategy. It could save you thousands of dollars over the loan term.

2. You may be able to extend your loan term

Extending the loan term can help make the monthly payments more affordable. Private student loan terms are generally between five years and fifteen years. When you use home equity to pay off your debt, you can extend the loan term up to 30 years. The longer loan term will lower the monthly payments, making them more affordable.

3. You may be able to cut down the number of student loans

This will depend on how much equity you can tap into and how many loans you’re dealing with. You use the equity to fully pay off a select few student loans. Ideally, you should pay off the student loans with the highest interest first. This will reduce the number of loans you have to pay off. Even better, you will have paid off your most expensive loans, reducing the total interest that accrues.

Disadvantages Of Using Home Equity To Pay Off Student Loans

1. You risk losing your home if you can’t repay

The reason home equity loans have lower interest rates is because they are secured loans. Your home is the collateral for these loans. Using your home equity to pay off student loans can save you money in interest. But if you default on the home equity loan, the lender can foreclose on your home.

Before using home equity to pay student loans, you must be 100% that you’ll be able to pay back the loan. It’s not worth putting your home at risk to save money on interest.

2. You could lose out on federal student loan protections

Federal student loans come with a few important borrower protections. You have access to income-driven repayment plans as well as forbearance and deferment options. You can also get part of your debt forgiven if you qualify for the Teacher or Public Service Loan Forgiveness Programs. These protections can be life-savers if you suffer any financial hardship. If you use home equity to pay off these loans, you’ll lose access to these protections.

It’s worth paying off your federal student loans using home equity only if your finances are strong. And if you’re very sure you’re not going to need any of the protections associated with federal student loans.

3. Home equity debt is only tax deductible when used towards home improvements

Homeowners generally tap into their home equity to free up cash for home improvements. The added benefit is, when used for this purpose, the interest on the home equity loan is tax deductible. When a home equity loan is used to pay off student loans, you lose out on this benefit.

Using home equity to pay off student loans has a few great advantages. But it also has some serious downsides. Take time to understand the full impact of choosing this option to pay off your student loans.

Consider refinancing if you’re looking to pay off your student debt without risking your home or the borrower protections.

Or if you have only a small amount of debt, consider taking a personal loan. It’s a lot less riskier than using your home equity to pay off debt.