If you’re struggling with student loan debt, you may be wondering how to pay off your loans as quickly as possible. One option you might’ve considered is applying for a home equity line of credit (HELOC) and using that money to repay your student debt. While you can use a HELOC to pay off student loans, we don’t recommend it.
Here’s what to know about the dangers of using a HELOC to pay off debt, plus some other repayment options to consider instead.
What Is a HELOC?
A HELOC is a line of credit you borrow from your home equity. With a HELOC, your lender will typically let you borrow up to a specific limit — often up to 85% of your home’s appraised value minus other loans. For instance, if your home is valued at $300,000 and you have a $200,000 mortgage, you have $100,000 in total equity but can only borrow $85,000, or 85%.
With a HELOC, you can borrow against your credit line up to the set limit during what’s known as a ‘draw period.’ Draw periods typically last five or ten years, and you can make interest-only payments during that time. After that, you enter a repayment period, during which you’ll make monthly principal and interest payments.
Unlike many other forms of financing, such as personal loans, HELOCs typically have variable interest rates, meaning your rate can change over time. You’ll also pay upfront fees, such as closing costs, when you take out a HELOC.
3 Risks When Using a HELOC to Pay Down Student Debt
While HELOCs are a flexible form of financing, they’re likely not your best option for paying down student debt. Here are some risks of using a HELOC for this purpose.
1. You’re putting your house at risk
HELOCs are secured credit lines for which your house is collateral, so you could lose your home to foreclosure if you can’t make your payments. If you suddenly can’t afford your HELOC payments because your rate increased or your income decreased, your home might be at risk.
By contrast, student loan debt is unsecured, meaning it requires no collateral. You don’t get a free pass when you miss student loan payments, though. After 270 days of missed federal student loan payments, your debt goes into default. This will affect your credit score and may lead to wage garnishment.
2. Your payments can vary based on the market
Generally, HELOCs have variable rates, meaning your rate — and your payments — can increase over time. There is no predicting if or when your interest rate may rise; instead, it depends on market conditions. Although HELOC interest rates are typically capped, these caps can vary and be as much as a 15% difference from your initial interest rate.
3. You don’t have as much payment flexibility
If you suddenly can’t afford your HELOC payments, it may be nearly impossible to change your payment schedule. However, with federal student loans, you have the option of deferment or forbearance.
Better Ways to Pay Off Student Loan Debt
Fortunately, there are several alternatives for paying off your student loan debt. You could consider the following instead of a HELOC:
1. Refinance Student Loans
Refinancing your student loans could help you reduce your rate or pay off your student loans more quickly, both of which might help you save on interest costs. ELFI’s student loan refinancing calculator can provide insight into your potential savings.
2. Change Your Repayment Plan
Federal student loans have a standard 10-year standard repayment period. But it’s possible to change your repayment plan to make your payments more affordable. For instance, you might opt for an income-based repayment option that reduces your monthly payments. Learn more about federal student loan repayment plans or contact your loan servicer for insight into your options.
3. Auto-Pay Discounts
Some lenders allow you to set up automatic payments, providing you with an interest rate reduction of 0.25% to 0.50% in return. But it’s worth noting that certain lenders don’t offer this option. Instead, they might build in cost savings based on your good credit, rather than discounting your rate for setting up automatic payments.
The Bottom Line
Using a HELOC to repay your student loans is a risky move. Fortunately, many other options exist if you want to pay them off faster. Before “betting the house” to pay down your student debt, consider refinancing, modifying your repayment plan, making extra payments, or taking other steps to reduce your rate.
If you’re considering refinancing your student loans, you can prequalify with ELFI in just minutes without affecting your credit score. A personal Student Loan Advisor is standing by to answer your questions and help make the process simple.
