Deciding to use home equity to pay for college

If you’re gearing up to send a child to college, the cost can feel overwhelming. A home equity line of credit (HELOC) or home equity loan could help pay for it — but before leveraging your equity, you’ll need to balance a number of considerations.

What is home equity and how can you use it?

Home equity is the difference between what your home is worth and what you still owe on your mortgage. For example, if you were to have $170,000 remaining to pay off on your mortgage and your home was worth $400,000, you’d have $230,000 in equity.

Homeowners accumulate equity by making mortgage payments and when their property’s value rises. There has been a huge increase in equity due to the surging housing market: In fact, collective home equity in the U.S. recently hit a record $27.8 trillion, according to the Federal Reserve.

Homeowners tap their equity for a variety of big expenses, including major home improvement projects, large medical bills and higher education costs.

When you use your home’s equity to pay for college, you can get a home equity loan, a type of second mortgage that offers a lump sum you can use for tuition, room, board and any other costs. You’ll pay the loan back in monthly installments at a fixed interest rate and over a set period, sometimes as long as 30 years.

Instead of a home equity loan, you could choose a HELOC, which operates more like a credit card. HELOC rates are variable, and you can access the money as needed. A HELOC might be better for some of the smaller expenses of college, like books, food and other everyday costs.

HELOCs and home equity loans vs. student loans

While you can access your home’s equity for any purpose, student loans are solely for covering the costs related to earning a degree.

Student loans can come from either federal or private sources. On the private lending side, rates can be very high, while federal lending programs offer lower fixed rates. You can borrow a loan in the student’s name or in the parent’s name.

HELOCs and home equity loans come with the drawback of putting your house on the line. The other downside: You won’t be able to deduct the interest on your taxes if you use the funds to pay for college. However, there are benefits to either option, including a wider range of repayment options and the ability to qualify with subpar credit.

Should I use home equity to pay for college?

There’s no one-size-fits-all answer regarding whether a home equity loan is the right choice to cover college costs. You’ll need to think about how much money you need, how comfortable you are with taking on additional debt, your future plans and how much a home equity loan will cost versus other financing options. Ask yourself:

What are your student loan options?

Student loans come in two packages: federal student loans, which involve borrowing money from the government and make up the bulk of all student lending; and private student loans, which come from for-profit institutions. Federal student loans come with fixed lower interest rates for undergraduate students and higher rates for parents and graduate students. Private student loans can have a range of fixed or variable interest rates. Students rarely have much credit, so if your child is borrowing without you as a co-signer, their rate can be much closer to credit card territory. Paying that off can prove to be much more daunting than writing a thesis or taking any final exams.

What are current home equity rates?

While rates on HELOCs and home equity loans have been lower historically (lenders are willing to offer better deals since you’re putting your house up as collateral), they have been rising quickly, almost comparable with current student loan rates. For a similar financing cost, it might make more sense to go with a student loan at this time.

How close are you to retirement?

Borrowing money to pay for a child’s education isn’t just about their future; you also need to think about the big picture for you. If you’re nearing the end of your working years, you’ll need to be laser-focused on your budget to ensure you can pay back the debt (whether a home equity or student loan) while covering your own expenses.

How many college tuitions do you need to cover?

If you have multiple children heading off to college, a home equity loan might not provide enough money to handle both sets of tuition, room and board, unless you own a high-priced home and have a significant amount of equity. You might need to arrange for multiple loans, both home equity and a student loan, to pay for everything.

What does your student’s future look like?

It might be too early to know what your child will do after graduation, but if they have a set career path already, they might be eligible for student loan forgiveness in the future. Teachers, government employees and employees at some non-profit organizations can eventually have a portion of remaining debt canceled after a certain point. In contrast, with a home equity loan, you’ll need to pay every dollar back.

Should you use this opportunity to help your child grow?

As your child begins college, now might be the time to help them understand what it takes to make an investment in their higher education. By opting for a traditional student loan with their name on it, you might instill a deeper sense of responsibility to go to class, apply for that internship and find a good job to pay all that money back.

Risks of a home equity loan for college

• You’re putting your home at risk. When you take out a home equity loan, your home is on the line as collateral. If you fall on hard times and can’t afford to make your payments, your mortgage lender could foreclose.
• Your property value could decrease. Losing value in your home might seem impossible right now, but prices don’t always follow the rapid upward trajectory we’ve seen in recent years. (Think about the housing crash in 2008.) If your home value drops significantly, you could find yourself owing more than it’s worth.
• You’re adding to your debt. Taking on more debt can strain your finances and add to your stress. You need to make sure you’re comfortable sleeping at night knowing your bills are getting bigger.

How to pull out home equity for college

If you feel like tapping your home equity is the right decision, here’s how to get started:

1. Estimate your equity. Your home’s value is not the number you initially paid for it. Home prices tend to appreciate, and they have done so at a frenetic pace over the past two years. Estimate what your house is worth to get a sense of how much equity you really have.
2. Know your credit score (and take steps to improve it if necessary). While you can get a home equity loan with bad credit, you won’t qualify for the lowest rates. Check your credit score before you apply. Most lenders reserve the best loan terms for borrowers with scores of 740 and above.
3. Compare lenders. Consider at least three home equity lenders and compare rates, fees, term lengths, maximum loan amounts, credit requirements and more. Consider other features you might need down the line,, as well, such as the ability to convert a variable-rate HELOC to a fixed-rate home equity loan.

Alternatives to using home equity for college

Putting your home on the line for college can be risky. If tapping your home equity doesn’t feel like the right choice, consider these other routes to come up with the necessary funds.

• Grants and scholarships – While your child applies for admission to college, have them apply for grants and scholarship opportunities. Many universities offer merit-based scholarships that reward academic track record, but there are other places to turn for financial assistance, as well. Some scholarships are small —  just $500 — but they can add up to cover the entire bill. Discover’s Scholarship tool includes more than three million scholarships for just about every kind of student.
• Financial aid – Make sure you complete the FAFSA (Free Application for Federal Student Aid) application, which can help your student qualify for monetary assistance based on your income.
• Work-study programs – Monitor the computer lab, grade papers, lead campus tours — many colleges offer work-study positions for students who qualify for financial assistance. Students will earn at least the federal minimum wage (and much more in some cases) and the money can help cover a portion of the bill for their studies.
• Payment plans – Many colleges offer monthly payment plans, which might be easier to manage than handing over a large check at the beginning of the semester.

Bottom line

Using a HELOC or home equity loan to pay for college isn’t for everyone. While they have benefits, it’s getting more expensive to borrow against your home due to rising interest rates. Be sure to crunch the numbers between monthly payments on the home equity loan versus a student loan. Don’t forget that a HELOC, which can come with an especially low introductory interest rate for 12 months or 24 months, can be helpful for smaller expenses like paying for books and supplies. If you do wind up tapping your home equity for your child’s education, it’s essential to ensure they understand what taking on more debt means for you as a parent. They might be leaving home, but you’re staying put, so they need to make your investment worthwhile.