Should You Use Your Home Equity to Pay Off Student Loans? 

Key takeaways:  

• Using accrued home equity to pay down student loan debt can be a smart financial move. 

• There are several ways homeowners can access their home equity, and each has its pros and cons. 

While student loan forgiveness programs have provided some relief to many Americans with college debt, more than 43 million still have some student loan debt to pay off. 

If you’re one of them, you may have considered using the accrued value of your home to pay off your debt. On average, Americans with student loan debt have a balance of about $40,000, while the average homeowner has approximately $206,000 in accrued home equity.  

In this article, we’ll review the various options for tapping home equity, and run through the pros and cons of each.  

Ways to access your home equity 

Cash-out refinance 

You can think of a cash-out refinance as getting a new mortgage to replace your old one. In most cash-out refinances, homeowners get a mortgage for a bit more than the amount they owe on their existing mortgage and receive the difference between the two in cash.  

There are advantages to cash-out refinances, including the fact that you can use that cash for whatever you want. It can be a big-ticket item like paying down loans, or just for day-to-day living expenses.  

But there are also some big drawbacks. Among them: interest rates are very high right now, and therefore probably much higher than the rate that you are currently paying on your existing mortgage. Also, getting a mortgage is always time-consuming, requiring you to shop around and produce lots of documentation. You’ll also need a strong credit score to get the best deal. 

Home equity loan 

Home equity loans and their cousins, home equity lines of credit, are often lumped together, but in fact they are very different. As the name suggests, home equity loans are for a set amount with an interest rate that’s fixed over the life of the loan. They are in effect second mortgages and use the home as collateral.  

There are a lot of reasons to skip home equity loans right now. High interest rates are one reason. To qualify for a home equity loan, you also need strong credit and your home’s loan to value ratio must generally be about 85% or lower. (Your loan-to-value ratio is the amount of the loan divided by the value of your home.) 

What’s more, taking out a home equity loan means taking on more debt – not the wisest course of action if you’re trying to get out of your student loans. 

Home equity line of credit (HELOC) 

A home equity line of credit also taps your home equity but differs from loans in that you may qualify for a certain amount of credit, and then can draw on it only when and if you need it. That’s a nice contrast from home equity loans, but the downside is that most HELOC interest rates fluctuate over time. (There are some fixed-rate HELOCs available, but they usually come with even higher rates.) 

As with home equity loans, there is a process for applying and qualifications you must meet. Like a home equity loan, a HELOC uses your home as collateral. And it’s still a loan, so you are still taking on more debt. There could be better ways to manage your student loan debt. 

Reverse mortgage 

Reverse mortgages, which are available only to Americans over 62, may be a good option for some people, but they also come with significant risks.  

As the name suggests, a reverse mortgage does things a bit backwards, with the bank paying the homeowner a monthly amount in exchange for an increasing share of the home’s equity. The homeowner retains the title to the home, but that can change if they fall behind on property taxes or insurance payments, let the home fall into disrepair, or move out. Of course, selling the home or passing away also ends the reverse mortgage agreement.  

Rates for reverse mortgages are roughly in line with or a bit higher than those for traditional, or “forward” mortgages – in the mid 7% range as of summer 2024. Variable rates are a bit lower, but they are indeed variable and can change at any time.  

Reverse mortgage closing costs can be higher than those of traditional mortgages. There are also origination fees, loan servicing fees, interest, monthly mortgage insurance premiums and an upfront mortgage insurance premium. In addition, to qualify for a reverse mortgage, you must complete a federally approved counseling session, which takes time and costs a nominal amount.  

With all those drawbacks, reverse mortgages require careful consideration. It’s likely that you have better options for paying off student debt. 

Home Equity Agreement 

A Home Equity Agreement (HEA) is a newer alternative to the options listed above. HEAs allow homeowners to receive cash up front in exchange for a portion of the future value of their home. Homeowners can buy back their equity at any time during the agreement term, often 10 years, which is typically when they sell the home.  

HEAs have been designed to address many of the downsides of the products listed above. For one thing, they are not debt, which makes them an ideal strategy for paying down other forms of debt, like student loans. They also have a lower qualification threshold than HELOCs or home equity loans. For example, credit scores as low as the 500s may qualify.  

Homeowners continue to live in their home as they did before entering the agreement, and HEAs do not constitute a second mortgage.  

For all the reasons listed above, HEAs, which were created to solve the problems inherent in other home equity products, may be a better option. But tapping home equity is a big step, and you should do your homework about the options that feel right for you. 

Conclusion 

Using your accrued home equity to pay off your student loans may be a wise financial move. There are more choices than ever to help you make that a reality.