Dear Dr. Don,
I have about $30,000 in student loans at 6 percent. Is it legal to put it on my parents' home equity line -- which has a 3 percent rate -- and then pay them back? They have no problem backing me and trust me to pay it off. (I have a steady job and could easily pay more.)
-- Scott Scholar
It's not illegal for your parents to repay your student loans with their home equity line of credit and for you to make loan payments to them. You'll lose any tax deductibility of the interest expense, although your parents may benefit from the deductibility of the HELOC interest expense.
There are a couple of other things to consider before taking this approach. For starters, your parents' credit score may go down because of the increased utilization of the HELOC.
Also, the HELOC interest rate is a variable rate, typically at a spread to the prime rate. You can track the prime rate on Bankrate's Rate Watch page. The prime rate is currently 3.25 percent, which should mean your parent's HELOC is priced at prime, less 0.25 percent.
While there are no immediate concerns over rising short-term interest rates, the rate can't go much lower, leaving it nowhere to go but up. How long will you take to pay off the loan?
Your parents should also review the HELOC documents. A typical HELOC has a limited number of years the borrower can draw against the line of credit. At the end of that draw period, the line becomes an amortized loan, with payments high enough to cover the interest expense and pay off the loan over a 10- to 20-year term.
Some HELOCs are structured to have a balloon payment at the end of the draw period. A balloon payment structure would not be beneficial to you or your parents.
Your parents have pledged the value of their home as security for the lender. At a minimum, you should have a loan agreement in place with them as you borrow to restructure student loan debt.
There are some IRS-related concerns when making loans to family members. The law is nuanced enough that I'm going to recommend your parents work with a tax professional in structuring the loan so as to manage any interest income and gift tax considerations that could come into play.
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