Can You Use A Home Equity Loan For College Expenses?
September 01, 2023 8-minute read
Author: Patrick Russo
With the price of college tuition skyrocketing in recent years, potential college students and their parents are looking for any way to help cover the costs. If you have a large amount of equity built up in your home, using a home equity loan for college tuition may be right for you. Find out below how you can utilize your home’s equity to help pay for educational expenses (even with lower credit).
You Can Use A Home Equity Loan For College Tuition
Home equity loans are an excellent tool to receive a lump sum payment for large expenses. With the importance and price of college education on the rise, using the money you receive from a home equity loan on college tuition may be a good idea for several reasons. However, this long-term solution is also a long-term responsibility that may not be right for everyone. It is recommended you research other options and speak to a financial advisor who can make recommendations based on your situation and goals.
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How To Get A Home Equity Loan For College Tuition
First, make sure you have enough equity in your home to borrow. Equity is the difference between your home value and what you owe on your mortgage. Most lenders require that you have at least 15% – 20% of equity to get a home equity loan.
Once you find a lender, you must provide them with financial documentation to ensure your ability to repay the loan. You’ll also need to have an appraisal on the home to verify its value, which will determine how much equity you have and how much you can borrow. Once approved, you’ll close on the loan and receive a lump sum payment that you can use for your child’s or your own college education.
The Pros Of Using A Home Equity Loan To Pay For College
Below are some of the primary benefits of using a home equity loan to pay for college.
Potentially Lower Interest Rates
One of the most enticing factors of home equity loans is the relatively lower interest rates they offer compared to other high-interest loans. For example, paying for college on a credit card or a personal loan would be much more expensive in the long run compared to a home equity loan. Even if you did get an excellent rate on either of these options, you most likely would not be able to borrow the amount required to cover the costs of college education. With a home equity loan, you can get more favorable rates because you put your home up as collateral. Since the loan is backed by such a valuable asset, financial institutions are more willing to lend you a large amount of money.
Interest Rates That Won’t Change
Home equity loan interest rates are typically fixed, meaning you will make the same monthly payment no matter how economic conditions change over the life of the loan. This can make it much easier to plan for your future finances and give you more confidence that you’ll be able to afford the loan. Other options to pay for college tuition, such as private student loans, may not offer fixed interest rates. That means if interest rates increase over the life of your loan, you will have to make larger monthly payments. This uncertainty can make it much more difficult to plan for your future and make financial decisions much more stressful.
Potentially Easier Qualification Requirements
Your home’s equity is an excellent tool to qualify for a larger loan with better rates. This is especially true if some previous financial hardships have caused you to have bad credit. If you’re asking for an especially large sum of money or have a history of not making debt payments, lenders need a solid incentive to allow you to borrow from them. That’s where your home comes in. If a lender has collateral, their investment is better protected because they could sell your home to recoup their losses. While this may make the agreement riskier for you, it gives lenders a reason to provide a loan that may be large enough to cover the costs of college tuition at reasonable rates, even if you don’t have a stellar credit history. However, it’s important to keep in mind that you must still meet the lender’s minimum credit score requirements to get the loan, which is typically around 620. A lower credit score will also result in less favorable terms.
The Cons Of Using A Home Equity Loan To Pay For College
Keep in mind some of the downsides of using a home equity loan for college tuition below.
Your House Is Collateral
While your home is the valuable asset that allows for many of the pros mentioned above, there is one big con to using a home equity loan to pay for college. If you run into financial hardship and cannot make the payments on your home equity loan (or your original mortgage loan), you could risk losing your home. If you’re at risk of defaulting on your loan, don’t wait until the official foreclosure proceedings begin to take action. Your lender does not want you to default on your loans if there is potential to fix the situation. Talk to them about the options you may have.
Loan Limits May Be Too Small
The amount of the lump sum you receive from a home equity loan depends on the amount of equity you own in your home. You can build equity in your home by making payments toward the principal and waiting as the value of the home appreciates over time. The longer you own a home and the more mortgage payments you make, the more equity you will own. If you don’t have enough equity to cover the rising costs of college, a this type of loan may not be sufficient.
The Approval Process Takes Time
The approval process for home equity loans can take weeks, so they’re not the best option if you need immediate assistance with college tuition payments. Once you find the right lender for you, you must present them with financial documentation, such as proof of employment, recent pay stubs and tax returns. Most lenders will also require you to get a home appraisal to confirm the value of your home. Once the lender has all of this information and approves you for the loan, then you will receive the lump sum payment, most likely by wire transfer.
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Other Ways To Pay For College
Home equity loans are not the only way to pay for college – and may not be the best way for you. Below are some of the most popular alternatives to consider.
Government Student Loans
Federal student loans are often the first option for students and their parents looking to pay for college. Federal loans are funded by the government and incentivize pursuing college education through multiple benefits such as fixed interest rates and flexible repayment plans. Federal loans are also deferred until at least 6 months after college so you can focus on your education and getting a job before you have to worry about paying back the loans. If you have trouble repaying your loan, the government gives you multiple options for assistance. You may qualify for a loan subsidy or be able to temporarily lower or postpone your payments. For most federal student loans, you don’t even need to get a credit check to qualify.
Unfortunately, the major downside to federal loans is that there is a limit to how much you can borrow that may not meet the extreme costs of college tuition today. Student’s that are still dependent on their parents can only borrow $31,000 total for their entire college career, while independent students can borrow $57,500. Since these amounts cannot cover the total expenses of many college tuitions today, students and their parents often must look for alternatives.
Private Student Loans
Private student loans are available for students whose tuition is not covered by federal student loans. Instead of the government sponsoring the loans, private student loans are funded by private banks, credit unions, state agencies or the schools themselves. They’re typically more expensive than federal student loans and do not offer the same flexibility or benefits. Private loans can have variable rates that change with economic conditions and may require a credit check or a cosigner with good credit. They also have less flexible repayment options than federal loans. Private student loans cannot be explained as generally as federal student loans, either, because they can vary widely depending on who your lender is and the terms of your loan. That is why it is essential to shop around for the best deals and thoroughly understand your loan terms before signing them. While private loans may have more stringent and expensive requirements, they do not have a maximum limit on how much you can borrow. This makes them a popular tool for students and their parents who have reached the limit for federal student loans.
Personal loans are best used to make up for a smaller gap between your college expenses and what you’re able to pay. Unlike a home equity loan, you do not have to offer any collateral to receive a personal loan. While this saves you from risking another valuable asset, it also means that you’ll likely have to pay higher interest rates and receive a smaller loan amount than you would with a home equity loan. Personal loans also typically have higher interest rates than federal or private student loans and may not offer repayment terms that are conducive to the college timeline. However, personal loans can be used for any payments at your discretion, so they are an option for other college expenses if you feel you need them.
Credit cards typically have the highest interest rates, often over 20%. On top of these high rates, many colleges charge convenience fees of 2% to 3% if you pay your tuition with a credit card. While some credit cards may have rewards programs that benefit you for spending more, these convenience fees will often negate those rewards. It is not recommended to use credit cards for high college expenses, like tuition.
How To Decide If A Home Equity Loan Is The Best Option
Here is what to consider before making a final decision.
Consider How Much Equity You Have In Your Home
To get a home equity loan, lenders typically require you to have at least 15% – 20% equity in your home and will not allow you to liquidate all of the equity you have. To determine how much you could receive with a home equity loan, you can calculate your loan-to-value ratio (LTV). Let’s say your home is worth $300,000, you have $150,000 left to pay on your original mortgage, and your lender will allow you to borrow 80% of your equity with a home equity loan. To determine how much your lump sum payment could be, follow the calculations below:
$300,000 x 0.8 = $240,000
$240,000 - $150,000 = $90,000
In this example, you would get $90,000 as a lump sum payment. However, you must keep in mind that you will also have to pay closing costs that equal 2% – 6% of the loan amount, or $1,800 to $5,400 in this example.
Think About Your Timeframe
As mentioned above, home equity loans are not granted overnight. They require multiple-weeks-long application and approval processes that involve extensive research and verification on your finances. All of this work cannot be stuffed into a short time period if you need funds for your college education as soon as possible.
Consider Your Budget
Home equity loans are essentially a second mortgage on your home that you’ll have repay on top of your original mortgage. That means, you’ll have two mortgage payments every month. Your ability to manage both of these payments at once may require significant financial planning even if you have a steady income.
Factor In Your Age
If you’re approaching retirement age or plan to retire before your loan term is complete, making both payments may be even harder. Make sure to strongly consider your age and how much longer you desire to work before making the decision to apply for a home equity loan.
The Bottom Line
Using a home equity loan for college tuition can be a wise investment, depending on your financial situation and goals. If you have a large amount of equity built up in your home, home equity loans allow you to take advantage of it by providing lower, fixed interest rates. However, they may not be the best option if you don’t want to take the risk of losing your home or need the money quickly. While you research lenders that provide home equity loans, you may also want to look into alternative sources, such as government or private student loans. If you’ve completed your research and are confident that a home equity loan is the right option for you and your family, apply online with Rocket Mortgage® today!
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