Are Student Loans A Good Reason For A Second Mortgage?
The huge increase in home values in recent years means that many homeowners can begin to think about replacing student debt with a second mortgage.
But is it wise to swap student debt for real estate financing? And is it possible that you can simply pay off student debt in a few years with real estate financing?Verify your new rate (Oct 21st, 2018)
Home Equity For Student Loans: Not Just About Rates
Rates for new federally-backed student loans range from 4.45 percent to seven percent as of July 1st, according to the Department of Education. Given that real estate financing is often cheaper, can it make sense to dump school debt for a home equity loan or line of credit?
If the question were merely an issue of rates, it would be fairly simple to answer. However, you must consider that there are other differences between real estate and school debt.
For instance, student debt has several options which are not generally available with real estate financing.
A student loan deferment allows you to postpone repayment of your loan under certain conditions. For instance, if you enroll in graduate school or join the Peace Corp, you may be able to temporarily put off repayment.
If you have a Direct Subsidized Loan, Subsidized Federal Stafford Loan, or a Federal Perkins Loan, your loan does not accrue interest during this time.
All other federal student loans continue to accrue interest during deferral. Any unpaid interest that accrued during the deferment period may be added to the principal balance.
Forbearance is similar to deferment in that you can temporarily suspend repayment of your loan. Your lender may grant you a forbearance if you are undergoing a qualifying financial hardship.
During forbearance, principal payments are postponed, but interest continues to accrue. You can choose to pay the interest on your loan as it becomes due, or have it added to your loan balance.
Outright forgiveness based on employment is another possibility. For instance, teachers, doctors and others may get their student loan balances forgiven if they agree to work in underserved areas.
If you work for the federal, state, local, or tribal government, a not-for-profit (501(c)(3)), certain other not-for-profit organizations that provide qualifying public services, AmeriCorps or Peace Corps, you may be able to cancel any remaining student debt after ten years.
So Why Would You Repay Student Loans With A Second Mortgage?
Given student loan advantages, why might it make sense to replace education debt with a second mortgage?
- You may not qualify for deferment, forbearance, or forgiveness.
- You may be able to save money with real estate financing, potentially a lot of money. The size of any savings depends on such factors as your current student loan interest rate, the cost of new financing, and how long such loans are outstanding.
- Your payment can be much lower, which can really improve your cash flow in the early stages of your career.
There are a number of ways to refinance student debt. Let’s imagine that you owe $65,000, have a home valued at $300,000, and that your existing mortgage balance is $150,000. You have good credit and qualify for a second mortgage.
If you take out a second mortgage for $65,000, your total mortgage debt is $215,000. Your loan-to-value ratio (LTV) is 72 percent. This is an extremely low LTV, which presents little risk to lenders. That should get you a lower interest rate.
One attraction of a second mortgage is that terms are up to 30 years. This means monthly payments can be rather affordable. For example, financing $65,000 at five percent over 30 years is $349 a month for principal and interest.
According to FinAid’s calculator, the typical payment for that same balance under standard repayment terms is $748.
Alternatively, a home equity line of credit (HELOC) allows you to instantly swap student debt for real estate debt.
For instance, the property in our example has a fair market value of $300,000. Let’s say a lender will allow a 75 percent combined loan-to-value ratio (CLTV). That’s total financing of $225,000, which equals your first mortgage of $150,000 plus a $75,000 line of credit.
That’s $65,000 to retire your student loans, plus an additional $10,000 for other purposes, or just for emergency cash if you need it later.
When considering a HELOC, you should understand how they work. A typical HELOC might last 15 years and operate like a giant credit card.
For instance, there can be a five-year “draw” period during which you can withdraw money from the HELOC account. You can tap the line, pay down your balance, and re-use it up to your credit limit, pretty much without restriction.
During the draw period, your interest rate is always variable, so budgeting for repayment can be tricky.
Next comes a 10-year “repayment” period. During this time, the entire debt must be repaid, and no withdrawals are allowed. Your interest rate will probably be variable, but some HELOCs allow you to lock in a fixed rate once you stop withdrawing money.
Because the repayment period is just 10 years, HELOC payments can be steep. If you owe $65,000 that must be repaid over ten years at 5 percent interest, the monthly cost will be $689.
Tenure and Second Mortgages
In looking at the basic mechanics of second mortgages and HELOCs, it might be good to also mention a very practical consideration, tenure. “Tenure” is the amount of time you are likely to own a home.
In 2016, the typical ownership period was ten years according to the National Association of Realtors. However, that period tends to be shorter for first-time buyers and younger homeowners.
According to the National Association of Realtors, most of the youngest homeowners kept their properties just four-to-five years, and one in five sold up in just two-to-three years.
This matters because once you borrow against your property, and you sell that property, you don’t have the option of extending your student loan repayment. The second mortgage or HELOC must be repaid when you sell your home.
That might be a good thing if your goal is to just eliminate your student debt for good, but it may cause problems if you’d prefer to continue financing it at a low rate over a longer time, and have the proceeds of your home sale to do other things.
Tenure is also important if you’re trying to choose between a HELOC, which may start out at a lower interest rate, and a fixed second mortgage, which may have a higher rate but is fixed and safer.
The less time you expect to keep your house, the less risky the HELOC becomes, because your rate is less likely to increase in a shorter time.
What Are Today’s Mortgage Rates?
Today’s mortgage rates for second mortgages and HELOCs are very attractive, and may be lower than what you’re paying for your student loans.
To get the best deal, obtain quotes from several competing lenders and compare them.Verify your new rate (Oct 21st, 2018)