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Pros and cons of paying for college with home equity

home equity loan college

January was the official kickoff of college-financial-aid season. Millions of Americans were beginning to figure out how to pay for their child’s higher education. And now that summer is just around the corner, college-tour season is about to begin.

You can bet that as parents tour college campuses with their children, financing the expense of four years at one of these institutions will not be far from their minds.

Unfortunately, for many parents, it's simply not possible to fund a degree from their savings or income -- not with the total annual cost of college hitting roughly $23,000 for the average four-year public school and about $46,000 for private schools, according to The College Board.

Should you use a home equity loan to pay for college?

If you're a homeowner, you have the option to use your home equity to pay for college. But should you? If you choose to do so, you’ll need to fill out a mortgage application in addition to the Free Application for Federal Student Aid (FAFSA) that you’re probably now completing.

Here are some distinct advantages and disadvantages to using a home equity loan to pay for college.

Advantage: Home equity loans are cheaper and tax deductible

With a home equity loan or a home equity line of credit, the two biggest positives are that home equity loans may be cheaper than other loans, plus the interest paid on a home equity loan is tax deductible.

"If you have a home equity loan, it's not only tax deductible and carries a low interest rate, it's also easily accessible and can provide immediate liquidity," says personal finance expert Jordan Goodman, the author of “Master Your Debt.”

Rates on home equity loans and lines of credit tend to fall in the 5 percent to 6 percent range, according to HSH.com - roughly comparable to the 4.66 percent interest rate on 2014-2015 federal Stafford loans, but far less than the 7.21 percent interest rate currently charged for federal PLUS loans made to parents.

Advantage: Home equity loans are quick and easy

When families need funds in a hurry, a home equity loan may be easier and faster to obtain under some circumstances. For instance, if you already have an equity line of credit, you can simply write a check from the home equity line to pay necessary college costs.

But if you borrow by co-signing or directly applying for a traditional student loan, a credit application and loan process are required for private student loans.

Advantage: There are fewer restrictions

Federal student loans don't require a credit check or co-borrower. However, the U.S. Department of Education does impose annual loan limits on federal loans:

  • $5,500 during an undergraduate's first year
  • $6,500 the second year
  • $7,500 for the third year and beyond

These loan caps may not give a family adequate borrowing power -- particularly if a student attends a high-cost college or university. So, home equity loans can be beneficial when higher funding amounts are needed, provided a homeowner has sufficient equity.

"Mortgage lenders aren't going to give you a loan for the full 100 percent of your home equity," says Goodman. "Many will lend up to 90 percent of the value of the home. So unless you've been paying your mortgage for a long time, there may not be a lot of equity to tap."

What do the professors think?

“I would be reluctant to use a HELOC to pay for a child’s college education,” says Dr. Mark Johnson of Loyola University. “Chances are that if you were approved for a sizable line of credit tied to your home, you would also qualify for a parent loan to help pay for college. Even though the interest rates on HELOCs are typically lower … and the interest can be tax deductible, they are risky loans.” But Dr. Arindam Bandopadhyaya of the University of Massachusetts Boston has a slightly different perspective on whether or not home equity is a smart way to fund higher education. “In terms of home equity being used for fund higher education, if financial aid and other sources of funds are not available at better terms, and if the college education is likely to result in increased job prospects eventually allowing the borrower to pay the loan off, then yes.”

Drawbacks of tapping home equity to pay for college

"A home equity loan certainly can be used to pay for college education, but it probably should be pretty far down on the list of options," says certified financial planner Donna Skeels Cygan, owner of Sage Future Financial. She suggests alternatives such as seeking scholarships and grants, having the student work part-time, or attending a less expensive school.

 Disadvantage: The house is on the line

"The risk with a home equity loan is that if the parents can't pay back the loan, then the house is collateral." Cygan says. "That's enormous risk and losing their house would be an incredibly high price to pay for funding a college education."

Goodman agrees.

"With a home equity loan, you're putting your house on the line," he says. "Besides, you're basically trading a hard asset, your home, in order to gain a soft asset, education."

Disadvantage: Little flexibility during hard times

Another downside is that these loans don't typically offer flexibility during periods of financial hardship. But those who borrow with federal student loans can readily obtain loan deferments, forbearance, and sometimes even loan forgiveness. Even private student lenders, such as Wells Fargo and Discover, now aid struggling student loan borrowers. For example, Wells Fargo is lowering interest rates on certain private student loans and Discover is offering student loan modifications to help borrowers avoid default.

Ultimately, the decision to borrow for college -- via a home equity line or line of credit -- may come down to your perspective on the value of higher education.

According to a recent survey from Spectrem Group's Millionaire Corner, 66 percent of millionaires believe a college education is valuable enough for people to take on debt.

"If you ask millionaires about their success, most attribute it to hard work," says Catherine McBreen, president of Millionaire Corner and managing director of Spectrem Group. "But in almost all cases, they will also say it was their education that allowed them to get where they are, and 90 percent of those millionaires have a college education."

"That's a strong case for college," she adds, "even if you have to borrow."

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(Image: Karen Roach/iStock)

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