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Cash-out refinance for student loans: new program makes it cheaper and smarter

Craig Berry
The Mortgage Reports contributor

In this article:

  • What is a cash-out refinance?
  • When it makes sense to use a cash-out refinance for student loans
  • Drawbacks of cash-out refinance

Fannie Mae has made it easier for homeowners to use the equity in their home to repay student loans. Paying off or refinancing student loans by way of a refinance may help you reduce your monthly expenses. But is a cash-out refinance for paying off student loan debt the best idea?

Verify your new rate (Nov 12th, 2018)

First, what is a cash-out refinance?

A cash-out refinance means replacing your existing mortgage with a bigger one. You get to take the difference in cash to spend as you wish. It’s a way to get cash without having to sell your house.

Breaking down the math, let’s say you have a home valued at $250,000, and you owe $175,000 on the mortgage. Refinancing via a conventional cash-out refinance, you could take out 80 percent of your home’s equity. You would pay off the $175k owed on your existing loan, and have the remaining $25,000 in cash.

Related: 4 cash-out refinances and how they work

Cash-out refinances have always been an option. Additional fees and higher interest rates are charged on any money borrowed that exceeds the balance of the loan being refinanced.

This is no longer the case with Fannie Mae’s rules for student loan refinancing.

Cash-out refinance for student loans

According to Fannie Mae, there are 8.5 million homeowners saddled with nearly $1.4 trillion in student loan debt. 41 percent have their own debt, and about one third co-signed on student loans for their children.

Fannie’s new program dubbed the Student Loan Cash-Out Refinance, helps homeowners with student loans pay down that education debt. Homeowners with college loans taken out on their behalf or their children can tap into their home’s equity via refinancing.

The lender will then use the cash from their equity to pay down the student debt. Fannie requires that the borrowed money be paid directly to the student loan lender.

Related: Mortgage approvals for people with student loans have gotten much easier in 2018

Fannie Mae’s rules require that at least one student loan be paid off fully from the proceeds of the cash-out refinance. Doing so means, unlike before, this type of refinance will no longer be considered a cash-out refinance.

Further, with the refinance no longer being considered a cash-out loan, the extra fees and higher interest rates no longer apply.

In terms of guidelines, non-cash-out refinance loans are also easier to qualify for as compared to a standard cash-out refinance.

Being underwriting and “priced” as a rate and term refinance, as opposed to a cash-out refinance, is a HUGE advantage.

You will need equity for a student loan cash-out refinance

Although Fannie Mae makes a cash-out refinance to pay off student loans easier, you still need equity in your home to do so.

Fannie Mae will require that you still have 20 percent in equity leftover after refinancing. This means you can borrow the amount owed on your existing mortgage, along with the amount to pay off at least one student loan in full, as well as the closing costs charged for refinancing, as long as you don’t exceed 80% of your home’s worth.

Related: FHA cash-out refinance guidelines (take out cash up to 85 percent of your property value)

All refinance loans, cash-out or otherwise, will require an appraisal completed on your home to verify its value.

Ever since the real estate crisis of 2008, appraisers aren’t as generous with their valuations. Be conservative when doing your own math. As always, it’s helpful to have a mortgage professional involved during this process as you weigh your options.

Some cons of a cash-out refinance to pay student loans

Student loans are unsecured debt. In other words, unlike your home, there’s no collateral in the event of student loan default.

By rolling in your student loan debt, you are in essence, putting everything on the line. By using your home to secure your student loan debt, your home becomes collateral for your student loans.

Related: Refinance your home without restarting the clock on your repayment

Further, if you were to lose your job, it’s likely that you could get a payment plan on a student loan. For example, the federal government provides several Income-Driven Repayment (IBR) plans. This isn’t necessarily going to be as easy when your student loan is now part of your mortgage debt.

The average student loan is based on a 10-year term. If you choose a 30-year fixed mortgage, you’re stretching that 10-year debt out over 30 years.

Should you consider rolling student loan debt into a mortgage?

You could lower your overall monthly debt burden by wrapping your student loans into your home payment.

  • By including your college debt in your mortgage debt, depending on current mortgage rates, you could reduce your interest rate
  • If you choose a shorter mortgage term, you could also reduce the number of payments owed on your student loans
  • There are certain tax incentives for which you may qualify now that your student loans are part of your mortgage (check with a finance or tax pro)

Be sure to consider the risks, the costs and your own situation before deciding whether or not you should roll your student loans in a mortgage.

If you’re in a stable place in your life with a steady job, and you have the equity, it may make sense to consider erasing your student loan debt with a new student loan cash-out refinance.

With mortgage interest rates still at historic lows, even if you’ve tried to a cash-out refinance previously and been turned down, it may be worth trying again, especially if your primary goal is to pay off student loan debt.

Verify your new rate (Nov 12th, 2018)