In a climate of lower housing interest rates, a home loan might seem like an attractive option for some parents to help shoulder the cost of paying for college.
“Since the downturn of ’08 and ’09, the lending environment has improved enough that some of the rates on home loans are more competitive over a Plus loan,” says Trish Gildea, senior financial planner at Summit Financial Corp. in Burlington, Massachusetts, when comparing home loans with federal parent education loans.
Of the parents who borrowed money to pay for college last year, 75 percent took a Parent Plus loan, 17 percent tapped into their home’s equity and 8 percent borrowed a private education loan, according to a recent Sallie Mae study.
On average, parents borrowed $7,406 through a home loan — an umbrella term that includes a home equity loan, a home equity line of credit known as a HELOC, cash-out refinance and a reverse mortgage, the survey found.
Wealth advisors say a HELOC is the most common choice for parents choosing a home loan to pay for school.
“The vast majority of them gravitate toward the HELOC because of the flexibility,” says Gildea.
A borrower can limit the amount to just what’s needed under a HELOC compared with a home equity loan, which requires taking out a lump sum. The minimum amount for a home equity loan can range between $10,000 and $25,000 at lending institutions, home loan experts say.
[Find out how to transfer Parent PLUS loans to a child.]
But before tapping into the value of your home to pay for education-related expenses, here are a couple of questions to ask.
1. What’s a HELOC? A HELOC is a type of home equity loan that allows borrowers to borrow a line of credit against the value of their home — it operates almost like credit card and usually has a floating interest rate.
A borrower with a $300,000 home who’s paid down $150,000 of his or her mortgage, for example, might be able to borrow up to $120,000 in a line of credit. But it doesn’t mean the borrower takes the full amount — he or she could take as little as $500, depending on the institution.
Typically a borrower needs to have at least 20 percent of equity in the home to qualify, but most wealth planners advise having more equity before taking out a HELOC.
“I recommend 35 to 40 percent because you want to be conservative in case there’s a drop in housing prices,” says Jason Ting, senior vice president of wealth management at Merrill Lynch Wealth Management. “As long as clients understand the risk, it seems like a viable option.”
Wealth planners also caution borrowers that HELOCs should only be used as a short-term measure to balance temporary cash flow — especially since the house is on the line.
“If you default on a home equity loan, you can lose the home,” says Mark Kantrowitz, vice president of strategy for Cappex.com, a college and scholarship search website.
2. Is a Parent Plus loan better than a HELOC? HELOCs often carry a lower interest — usually a variable rate around 3.99 percent, home loan experts say. Parent Plus loans, on the other hand, are much higher, carrying a 6.31 percent fixed interest rate along with a 4.23 percent origination fee.
[Get answers to frequently asked questions about parent PLUS loans.]
“The Parent Plus loan, although it went down, it’s still quite high,” say Peg Keough, founder of college planning firm Way to the Quad, based in Bellevue, Washington. “For some, it’s the only game in town if they have bad credit or don’t own a home.”
But despite the higher interest rate on the Plus loan, the federal loan comes with more protections such as loan deferment, flexible repayment options as well as the ability to discharge the debt.
3. Can a HELOC affect your financial aid? Taking out a home equity loan or HELOC can be counted toward your estimated family contribution on financial aid forms.
Experts say timing is important when it comes to a HELOC and filling out the FAFSA, the Free Application for Federal Student Aid that many schools use to determine financial aid awards.
“If the proceeds of a home equity or HELOC is in your bank account on the date you file the FAFSA, it must be reported as an asset — reducing eligibility for need-based aid,” says Kantrowitz from Cappex. “So timing of the loan drawdown matters.”
Ask these 10 questions before borrowing a [private student loan.]
4. What about a private education loan? Over the last couple of months, several private lenders have entered the education loan market . And some of these lenders offer rates as low as 4.25 percent, depending on a borrower’s credit history.
In comparing rates, Kantrowitz from Cappex.com says, “Interest rates on home equity loans may be lower than on private student loans.”
Keough , from Way to The Quad, tells her clients to research rates from all available options from home loans to education loans. For those with good credit, “credit unions and Wells Fargo are beating the Parents Plus loan,” she says. “It’s really important to look at the whole picture.”
Trying to fund your education? Get tips and more in the U.S. News Paying for College center.
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Weigh Whether to Use Your Home to Pay for College originally appeared on usnews.com
