“I bought my house back in 2002, right before that first gigantic spike in valuations and before the crash happened in 2008,” Barker says. “My house essentially tripled in value, and I ended up taking out a $100,000 home equity line of credit (HELOC).”
Barker used about half of this HELOC to refinish his basement and the other half to finish his undergraduate degree and earn his MBA at Strayer University. The factors at the time
Today, many homeowners are similarly seeing an increase in available equity with the recent rise in home values. With this source of funding at their fingertips, they may consider tapping into their home equity to cover the costs of college or graduate school. But that likely isn’t your best option.
Home equity loans and HELOCs come with a lot of risks, and today’s shaky housing market and rising interest rates make those risks even worse. Plus, tapping home equity to pay for school denies you opportunities for things like student loan forgiveness. That’s why experts say you’re probably better off using student loans to pay for school.
Why This MBA Grad Used a HELOC to Pay for Tuition
Barker earned his degree in business administration before moving into an MBA program. Because he already had a standing line of credit open on his home (and was simultaneously planning home renovations), he decided to tap into it to pay for school.
“I had the HELOC at my fingertips versus going through all of the student loan application paperwork,” Barker says.
Not only was the HELOC more convenient to Barker at the time, but it also appeared more affordable. “The interest rate on the HELOC was just 3% or 3.5%,” says Barker. “That was cheaper than the student loan rates, which were around 6% or 7%.”
While his interest rate on the HELOC was variable, it didn’t increase significantly over the years. He also had a 20-year repayment term and was able to make interest-only payments while in school.
Although Barker says his home dropped in value after 2008, he never owed more than it was worth. When he and his wife sold their home years later, they were able to pay off the HELOC completely and walk away with $70,000 to $80,000.
While using a HELOC to pay for college worked out for Barker, he attributes some of this good luck to timing.
“It worked for me, but a lot of that stuff was out of my control,” he says. “I couldn’t control that my house was going to triple in price because it went through a crazy period. I was able to take advantage of the situation, and it worked out in my favor and allowed me not to have any student loans.”
The Pros and Cons of Using Home Equity to Pay for Education
Tapping into your home equity might look like an affordable way to pay for education, especially if the interest rate you get is lower than what you’d find on a student loan. Plus, you can typically choose a long repayment term – up to 30 years – resulting in potentially low monthly payments.
However, relying on your home equity to pay for school comes with risks. A major one is that a home equity loan or HELOC is secured by your home. If you can’t pay it back, you could end up in foreclosure.
“The risk of losing your home is one of the most significant drawbacks,” says Mahesh Odhrani, certified financial planner (CFP) and president of Strategic Wealth Design, a Las Vegas financial planning firm. “What if you lose your job or can’t make the payments? You will be at risk of default, and you could be forced into foreclosure and lose your home.”
While home equity loans typically have fixed rates, HELOCs often have variable ones. If your rate increases over time, you could see your monthly payments go up and your long-term costs of borrowing rise, as well. Don’t forget to factor in closing costs, too.
If you max out your home equity for college, furthermore, you might not have anything to fall back on in the case of an emergency expense, warns Will Dunn, co-founder of Gravy, an app designed to help renters buy their first house.
“Ask yourself, what happens if I have some very unexpected medical expense that I need to cover?” Dunn says. “Is there enough buffer either in my savings account or from some other source to cover those things? Or am I going to be in a really tough spot?”
Federal student loans are eligible for certain protections in the case of financial hardship, such as deferment, forbearance, and income-driven repayment. Home equity loans and HELOCs, on the other hand, don’t qualify for the same range of repayment plans and programs as federal student loans do. They also don’t qualify for repayment pauses or the forgiveness proposed by the Biden Administration.
Alternative College Financing Options
Before tapping into your home equity to pay for college or graduate school, consider these options to fund your education.
Federal Student Loans
If you’re a U.S. citizen or eligible non-citizen, you could borrow federal student loans to pay for college or graduate school. Some options include subsidized loans, unsubsidized loans, and PLUS loans for graduate students or parents.
Interest rates range from 4.99% to 7.54%, depending on your year in school and loan type. These loans also come with an origination fee between 1.057% and 4.228%.
Federal student loans don’t require a cosigner and are eligible for a variety of programs, including forbearance, income-driven repayment, and forgiveness. Plus, you can typically choose repayment terms anywhere from 10 to 25 years, or up to 30 years if you consolidate and owe more than $60,000.
Because of this flexibility, federal student loans may be your best bet for paying for college or graduate school. However, it’s worth noting that federal student loans are notoriously difficult to discharge in bankruptcy and come with annual borrowing limits, meaning you may need an alternative source of funding to cover the full cost of your degree.
Private Student Loans
You might also consider a private student loan from a bank, credit union, or online lender. Rates and terms will vary by lender.
Private student loans are not eligible for federal repayment plans or forgiveness programs, but some lenders will let you postpone payments if you lose your job or go back to school.
You can usually borrow as much in private student loans as you need to cover your full cost of attendance, minus any other financial aid you’ve already received.
Private lenders look at your credit score and income before approving you for a loan. Most undergraduates need to apply with a cosigner to qualify for a private student loan.
If you have financial need, you could qualify for work-study, a program that provides on- and off-campus part-time jobs to students. By working part-time, you could earn income that covers some of your education costs.
While work-study probably won’t cover your full cost of attendance, it may provide enough to cover living expenses. Whether or not you qualify for work-study, you could also consider a non-work-study part-time job, which may pay even better than a work-study position.
Grants and Scholarships
You can find grants and scholarships from the federal and state governments, colleges and universities, and private organizations. Some are based on merit, others are centered around financial need, and some consider both.
The Pell Grant, for instance, is a federal grant for undergraduates with demonstrated financial need that you can access by submitting the Free Application for Federal Student Aid (FAFSA). Other grants and scholarships might have their own application processes, with some requiring reference letters and essays.
“Unlike loans, grants and scholarships don’t have to be paid back,” Odhrani says. “Eligibility varies for various grants and scholarships, so the student needs to do some legwork and find programs that they may qualify for.”
529 Plans and Other Savings
You can also use savings from 529 plans or another type of account to pay for tuition. These are tax advantaged accounts that help parents pay for their children’s college. According to Sallie Mae’s How America Pays for College 2021 report, 37% of parents used a college savings account, such as a 529 plan, to help pay for school.
Employer Tuition Assistance
Some employers offer tuition assistance to qualifying employees to help defray the costs of education. If you’re already in the workforce and thinking of going back to school, find out if your employer offers financial assistance toward your degree.
A home equity loan or HELOC could have lower rates than some student loans, but won’t qualify for the same variety of borrower protections.
Other Uses for a HELOC or Home Equity Loan
Tapping your home equity to pay for college or graduate school can be risky. Here are a few cases when borrowing a HELOC or home equity loan could be a better fit.
Using a HELOC or home equity loan to renovate or remodel your home might make more sense than using it for your education. When you renovate, you could add to the value of your home, thereby increasing the amount of equity you hold.
“In the case of putting an addition on to the home, a HELOC or home equity can make a lot of sense,” Dunn says.
Depending on the project, the amount you borrow to renovate your home could also be tax deductible, potentially resulting in savings during tax season.
If you’re juggling multiple bills with high interest rates, consolidating your debts into a home equity loan or line of credit might also make sense, especially if you can qualify for a lower rate. But as with borrowing for your education, be careful about securing your debt with your home.
Make sure the monthly payment fits your budget, so you don’t risk defaulting and losing your home. And look at the root causes of your various debts so you can avoid running into the same financial difficulties in the future.
Taking out a HELOC on your home for future emergency use can also make sense in some cases.
“I really like home equity lines of credit, because they’re a great tool to have in your pocket for when life arises and you need some short-term cash,” says Jason Krueger, CFP and private wealth advisor at Eventus Wealth Advisors.
According to Krueger, it shouldn’t cost much (if anything) to set up a HELOC, nor should it cost more than a nominal fee to maintain it. Interest won’t accrue until you borrow from it.
By keeping a HELOC in standby mode, you have a source of funding ready to go in the event you run into unexpected expenses that you can’t afford to cover with your emergency fund.