money Should You Refinance Your Mortgage to Pay Off Student Loans?
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This article first appeared on the Credible blog.
If you’ve got a large student loan, it could make sense to pay it off using the money from a cash-out refinance. This is usually known as a “student loan cash-out refinance.”
Rising home equity values may help you qualify for a cash-out refinance and borrow more money. In the first quarter of 2021, homes with a mortgage gained $33,400 in equity, the largest average equity gain in at least a decade, according to real estate data firm CoreLogic.
What is a student loan cash-out refinance?
A student loan cash-out refinance is a mortgage that allows you to use your home equity to pay down a student loan balance. This means you combine your mortgage and student loans into a new loan.
You can potentially reduce the interest rate you were paying on your educational debt as well, saving you more money in the process.
To qualify, you’ll typically need to use the cash to fully pay off a student loan in your name. The lender will send the cash straight to the student loan servicer at closing.
For example: Let’s say your home is valued at $200,000, your mortgage balance is $100,000, and you owe $50,000 in student loans. You could do a student loan cash-out refinance totaling $150,000, and your mortgage lender would use the $50,000 to pay off your student loan.
Types of student loan cash-out refinance loans
If you want to use your home equity to pay off your student loans, you have two options:
General cash-out refinance
Student loan cash-out refinance through Fannie Mae
General cash-out refinance
Best for: Homeowners who don’t qualify for Fannie Mae’s program or want to use their extra cash for multiple expenses
When you do a general cash-out refinance, you take out a new mortgage for more than you owe, pocket the cash, and pay down the new mortgage over time. You can use the money for any purpose, including paying off student loans.
To qualify, you’ll typically need to have:
A credit score of at least 620
A debt-to-income ratio under 50%
At least 20% equity in your home after closing on the cash-out refinance
Credible makes refinancing easy. You can see prequalified refinance rates from our partner lenders in just a few minutes. We also provide transparency into lender fees that other comparison sites typically don’t.
Fannie Mae’s Student Loan Solutions
Best for: Borrowers who can pay off their entire student loan with the cash-out proceeds
Fannie Mae’s Student Loan Solutions program is designed to help student loan borrowers better manage their monthly payments and qualify for a mortgage loan. One feature of the program allows homeowners to pay off their student loans using their home equity at lower rates.
Eligibility depends on several factors:
The funds from the cash-out refinance must fully pay off at least one student loan.
The student loan(s) must belong to the borrower who is applying for the refinance.
The loan must be underwritten through Desktop Underwriter, Fannie Mae’s automated underwriting system; manual underwriting is not permitted.
For a one-unit property, the borrower will need to meet standard cash-out refinance guidelines, including: a credit score of at least 620, a DTI of 50% or lower, and at least 20% equity in the home after closing.
Pros and cons of a student loan cash-out refinance
A student loan cash-out refinance pays off your student loans and may help you save money in some cases, but keep in mind, you’ll be responsible for a new mortgage.
Pros
You can get a better rate. A student loan cash-out refinance usually has lower rates compared to other lending options, like personal loans and home equity loans. So, if you qualify, you’ll likely save money in the process. Make sure you calculate the total interest bill, though, as lengthening the term may result in paying more interest.
You may qualify for certain tax incentives. For instance, the interest you pay on a student loan is typically tax deductible. The same goes for mortgage interest in some cases. The catch is that, unlike the student loan interest deduction, you’ll need to itemize your taxes in order to capture the savings on mortgage interest.
You simplify your payments. Consolidating two loans into one streamlines your payments, which may help you organize your finances and ensure you pay the bill on time.
Cons
The student loan debt doesn’t disappear. When you take money from a cash-out refinance to pay off your student loan, you’re moving debt from one place to another. You may save money in the process, but you’ll still need to eventually pay it off.
You give up certain borrower protections. If you’re paying off a federal student loan with the cash-out refinance, then you lose important borrower protections, such as income-based repayment plans and generous hardship options.
You risk foreclosure: By refinancing your mortgage to pay off student loan debt, you’re turning what was once unsecured debt into secured debt. This means your home is used as collateral. If you struggle to make payments on your new mortgage loan, you risk losing your home.
When to consider a student loan cash-out refinance
Before applying for a student loan cash-out refinance, ask yourself these questions:
What’s the interest rate on my student loan? Shifting your debt from a variable-rate student loan to a fixed-rate home loan can help make debt payments more predictable.
Will I save money by wrapping my student loan into my mortgage? If the interest rate on the cash-out refinance is lower than your student loan rate, then you’ll likely save money. Calculate how much interest you would pay on the original loan and by refinancing. You may not save money if you lengthen the loan term too much.
What kind of student loan do I have? It might not make sense to roll a federal loan into your mortgage because you’ll lose important borrower protections, such as forbearance, deferment, and income-driven repayment plans. But borrowers with private student loans might come out ahead when refinancing.
What are my other options? You could always refinance your student loans, do a less-risky rate-and-term refinance, or make biweekly student loan payments if you’re looking for ways to save money.
Alternatives to student loan cash-out refinancing
Using your home as collateral can be risky — so if you’re looking to play it safer, there are other options for paying down your student debt.
Refinance your student loans
Best for: Borrowers with private student loans
When you refinance a student loan, a private lender pays off your balance and issues you a new loan based on your creditworthiness. This can help you save money and lower your payments if you qualify for a student loan with a lower interest rate. With the savings, you can make larger student loan payments and pay down the balance quicker.
Visit Credible to compare mortgage refinance rates from various lenders in minutes,
Do a rate-and-term home refinance
Best for: Homeowners who can shave 0.75% off their mortgage rate
A rate-and-term mortgage refinance involves taking out a new mortgage with a new interest rate, new loan term, or both. You won’t borrow cash in the deal, if you lower your mortgage payment, you can use the savings toward your student loan debt.
Mortgage experts say refinancing is a smart move if you can lower your interest rate by at least 0.75%.
Make biweekly student loan payments
Best for: Borrowers who don’t qualify for a refinance, don’t want to pay closing fees on a refinance, or want to use a simple strategy
Most borrowers are only required to make one student loan payment a month, but you could pay every two weeks instead. With biweekly student loan payments, you’ll cut your bill in half and pay that amount every two weeks.
With this strategy, you’ll effectively make 26 half-payments, or 13 full payments, during the year. This can expedite your repayment and potentially help you save money, since interest will accrue on a smaller balance.
Visit Credible to find out if refinancing your mortgage is right for you.
About the author: Kim Porter is an expert in credit, mortgages, student loans, and debt management. She has been featured in U.S. News & World Report, Reviewed.com, Bankrate, Credit Karma, and more.
The post Should You Refinance Your Mortgage to Pay Off Student Loans? appeared first on Credible.
