Should I Take Out a Home Equity Loan for College?
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- Homeowners can borrow 80% or more of their home equity to pay for college.
- One major benefit is that interest rates are low compared to other types of loans.
- A drawback is that the property is used as collateral, putting your home at risk of foreclosure if you default.
- There are many alternative ways to pay for college without tapping into your home equity.
You can use a home equity loan — a loan backed by your home’s equity — to cover college costs, but should you?
That answer is ultimately a personal decision, but there are a few pros and cons to consider. Find out whether you should use a home equity loan to pay for college and how to do it.
How Can You Use a Home Equity Loan to Pay for College?
A home equity loan is a secured loan that uses your equity in the property as collateral. Your equity is the difference between the market value of your home and your mortgage balance. Typically, banks allow you to borrow up to 80% or 85% of your equity.
That means if your home value is $400,000 and your mortgage balance is $250,000. Your equity equals $150,000. You could apply to borrow between $120,000 and $127,500 — which can certainly go a long way in paying for college tuition.
You’ll still have to pay interest on the loan balance. However, the interest rate is usually lower than other types of loans and credit cards since your home is used as collateral to back the loan. Also called a second mortgage, you’ll make monthly payments in addition to your first mortgage until you repay the loan.
Pros and Cons of Using a Home Equity Loan to Pay for College
Using a home equity loan for college comes with both benefits and drawbacks. Here’s what to expect.
Benefits of Taking Out a Home Equity Loan for College
There are a few benefits to taking out a home equity loan for college, including:
- Lower rates: A home equity loan comes with low, competitive rates compared to some other student loan options because your home is used as collateral.
- Longer loan term: Home equity loans can last several years — anywhere from 5-30 years. So, if you borrow a large amount, that balance is spread out over a longer period, making your monthly payments more affordable.
- Fixed interest rates: Unlike most private student loans, home equity loans come with fixed interest rates. Your payment will be the same each month, giving you a predictable budget. So you could even use a home equity loan to pay off student loans with variable payments.
Drawbacks of Taking Out a Home Equity Loan for College
While home equity loans have some benefits compared to student loans, they also have some disadvantages:
- Home is at risk: Your house is used as collateral for a home equity loan. If you can’t keep up with the payments and head into default, you could potentially be forced into foreclosure.
- Closing costs and fees: There is a cost to taking out a home equity loan. Check with your lender to estimate closing costs and other fees. You may be able to add them to your loan balance, or you might have to pay upfront with cash.
- Appraisal may be required: Your lender will likely order an appraisal to confirm the value of your home (and your equity). That impacts how much of a loan you can apply for. Plus, appraisals can cost several hundred dollars (for which you are responsible) and can take several weeks or longer to schedule.
Should You Use a Home Equity Loan for College?
When deciding between a home equity loan for college and other financial aid options, here are some steps to take.
Complete the FAFSA
The Free Application for Federal Student Aid allows you to apply for financial help from the federal government. There are several types of financial aid your family may qualify for, including:
If you can cover college costs with scholarships, grants, and work-study, you might not need a home equity loan.
Apply for Scholarships
Scholarships can be based either on merit or financial need. You can search for programs that you (or your child) qualify for at your college or university or through private organizations, like nonprofits and community groups.
Consider Student Loan Options
If you qualify for federal student loans, see how the interest rate measures up to a home equity loan. Loans for undergraduates in the student’s name have a 4.99% interest rate. Loans for parents have a 7.54% interest rate.
In addition to federal student loans, private student loans are available to both students and parents. Students without an income or credit score may need a credit-worthy cosigner for the student loan. Private loans can have interest rates of anywhere from 3-13%.
Compared with federal and private student loan options, the average home equity loan interest rate is around 6.81% as of August 2022, according to Bankrate. If you qualify for a lower interest rate with federal or private loans, consider going with one of those options.
Federal student loans, in particular, offer relief options that private and home equity loans do not. For example, if you’re struggling with repayment, you might qualify for an income-driven repayment plan for your federal student loans. Taking out a home equity loan instead of a federal student loan also exempts you from the government’s Public Service Loan Forgiveness program.
Tips to Make College Cheaper
You might want to avoid loans altogether, and while that might seem nearly impossible, there are some ways to lessen college costs.
Contribute to a College Savings Plan
Parents and other relatives can contribute to a college savings plan to help pay for college. Since the funds can be invested to potentially grow over time, the earlier you start contributing, the better. There are some benefits to using a 529 college savings plan:
- Earnings are not taxed when used for eligible education expenses.
- Some states offer a tax deduction or credit for contributions.
- There are no income or annual contribution limits.
Attend a Cheaper College
College tuition prices have risen across the board, but in-state public schools still cost far less than their private counterparts. According to the National Center for Education Statistics (NCES), in the 2020-21 school year, the average in-state public school cost of tuition and fees was $9,349 for one year, while the average private college cost $32,825.
Attending an in-state school can save you big in the long run.
Go to Community College First
Attending community college is a cost-effective way to reduce tuition costs for a degree. Tuition and fees at a two-year, in-state school cost $3,242, according to NCES. That’s a savings of nearly $6,000 per year compared to an in-state public school.
Frequently Asked Questions About Using Home Equity Loans to Pay for College
Should I take money out of my house to pay for college?
There’s no one-size-fits-all answer to whether or not a home equity loan is right for you. It’s important to have a sizable emergency fund before using a home equity loan to pay for college so you can cover emergency expenses and not put your house at risk. If you don’t qualify for other federal financial aid and private loan interest rates are higher, it might be a good idea to use a home equity loan.
Is it a good idea to use a HELOC to pay for college?
A home equity line of credit (or HELOC) lets you borrow as much as you need against a line of credit — up to a certain limit. It can be good for college tuition because you only need to take out what you need when you need it rather than paying interest on a huge lump sum. But just like a home equity loan, HELOCs use your house as collateral, potentially putting it at risk of foreclosure.
Do people use home equity to pay for college?
According to a 2021 report from Sallie Mae, 6% of parents tapped into their home equity to help pay for college.
DISCLAIMER: The information provided on this website does not, and is not intended to, constitute professional financial advice; instead, all information, content, and materials available on this site are for general informational purposes only. Readers of this website should contact a professional advisor before making decisions about financial issues.