Should You Use a Mortgage to Refinance Student Loans?

Fannie Mae, the largest backer of mortgage credit in America, recently made it a little easier for homeowners to refinance their student loans. In an update to its Selling Guide, the mortgage giant introduced a student loan cash-out refinance feature, permitting originators that sell loans to Fannie Mae to offer a new refinance option for paying off one or more student loans.

That means you could potentially use a mortgage refi to consolidate your student loan debt. Student loan mortgage refis are relatively new. Fannie Mae and SoFi, an alternative lender that offers both student loans and mortgages, announced a pilot program for cash-out refinancing of student loans in November 2016. This new program is an expansion of that option, which was previously available only to SoFi customers.

Amy Jurek, a Realtor at RE/MAX Advantage Plus in Minneapolis/St. Paul, Minn., says people with home equity have always had a cash-out option, but it typically came with extra fees and higher interest rates. Jurek says the new program eliminates the extra fees and allows borrowers to refinance at lower mortgage interest rates. The policy change could allow homeowners to save a significant amount of money because interest rates on mortgages are typically much lower than those for student loans, especially private student loans and PLUS loans.

But is it a good idea?

Your student debt isn’t eliminated; it’s added to your mortgage loan.

This may be stating the obvious, but swapping mortgage debt for student loan debt doesn’t reduce your debt; it just trades one form of debt (student loan) for another (mortgage).

Brian Benham, president of Benham Advisory Group in Indianapolis, Ind., says refinancing student loans with a mortgage could be more appealing to borrowers with private student loans rather than federal student loans.

Although mortgage rates are on the rise, they are still at near-historic lows, hovering around 4%. Federal student loans are near the same levels. But private student loans can range anywhere from 3.9% up to near 13%. “If you’re at the upper end of the spectrum, refinancing may help you lower your rate and your monthly payments,” Benham says.

So, the first thing anyone considering using a mortgage to refinance student loans should consider is whether you will, in fact, get a lower interest rate. Even with a lower rate, it’s wise to consider whether you’ll save money over the long term. You may pay a lower rate but over a longer term. The standard student loan repayment plan is 10 years, and most mortgages are 30-year loans. Refinancing could save you money today, but result in more interest paid over time, so keep the big picture in mind.

You need to actually have equity in your home.

To be eligible for the cash-out refinance option, you must have a loan-to-value ratio of no more than 80%, and the cash-out must entirely pay off one or more of your student loans. That means you’ve got to have enough equity in your home to cover your entire student loan balance and still leave 20% of your home’s value that isn’t being borrowed against. That can be tough for newer homeowners who haven’t owned the home long enough to build up substantial equity.

To illustrate, say your home is valued at $100,000, your current mortgage balance is $60,000, and you have one student loan with a balance of $20,000. When you refinance your existing mortgage and student loan, the new loan amount would be $80,000. That scenario meets the 80% loan-to-value ratio, but if your existing mortgage or student loan balances were higher, you would not be eligible.

You’ll lose certain options.

Depending on the type of student loan you have, you could end up losing valuable benefits if you refinance student loans with a mortgage.

Income-driven repayment options

Federal student loan borrowers may be eligible for income-driven repayment plans that can help keep loan payments affordable with payment caps based on income and family size. Income-based repayment plans also forgive remaining debt, if any, after 25 years of qualifying payments. These programs can help borrowers avoid default – and preserve their credit – during periods of unemployment or other financial hardships.

Student loan forgiveness

In certain situations, employees in public service jobs can have their student loans forgiven. A percentage of the student loan is forgiven or discharged for each year of service completed, depending on the type of work performed. Private student loans don’t offer forgiveness, but if you have federal student loans and work as a teacher or in public service, including a military, nonprofit, or government job, you may be eligible for a variety of government programs that are not available when your student loan has been refinanced with a mortgage.

Economic hardship deferments and forbearances

Some federal student loan borrowers may be eligible for deferment or forbearance, allowing them to temporarily stop making student loan payments or temporarily reduce the amount they must pay. These programs can help avoid loan default in the event of job loss or other financial hardships and during service in the Peace Corps or military.

Borrowers may also be eligible for deferment if they decide to go back to school. Enrollment in a college or career school could qualify a student loan for deferment. Some mortgage lenders have loss mitigation programs to assist you if you experience a temporary reduction in income or other financial hardship, but eligibility varies by lender and is typically not available for homeowners returning to school.

You could lose out on tax benefits.

Traditional wisdom favors mortgage debt over other kinds of debt because mortgage debt is tax deductible. But to take advantage of that mortgage interest deduction on your taxes, you must itemize. In today’s low-interest rate environment, most taxpayers receive greater benefits from the standard deduction. As a reminder, taxpayers can choose to itemize deductions or take the standard deduction. According to the Tax Foundation, 68.5% of households choose to take the standard deduction, which means they receive no tax benefit from paying mortgage interest.

On the other hand, the student loan interest deduction allows taxpayers to deduct up to $2,500 in interest on federal and private student loans. Because it’s an “above-the-line” deduction, you can claim it even if you don’t itemize. It also reduces your Adjusted Gross Income (AGI), which could expand the availability of other tax benefits.

You could lose your home.

Unlike student debt, a mortgage is secured by collateral: your home. If you default on the mortgage, your lender ultimately has the right to foreclose on your home. Defaulting on student loans may ruin your credit, but at least you won’t lose the roof over your head.

Refinancing student loans with a mortgage could be an attractive option for homeowners with a stable career and secure income, but anyone with financial concerns should be careful about putting their home at risk. “Your home is a valuable asset,” Benham says, “so be sure to factor that in before cashing it out.” Cashing out your home equity puts you at risk of carrying a mortgage into retirement. If you do take this option, set up a plan and a budget so you can pay off your mortgage before you retire.

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