Post By: COYD Staff
For students who have their parent’s financial support while going to college, a Home Equity Loan or a Home Equity Line of Credit (HELOC) is generally a better alternative to private student loans. However, both private student loans and home equity loans are what we call alternative loans. Do not even explore alternative loans until you exhaust the Federal financial aid provided by grants, scholarship and federal loans. See previous posting to learn why.
So what are the advantages of home equity loans/HELOC over private student loans?
1. Lower interest rate than private student loans
As of June 4, 2010, the average national home equity rate on a $30K HELOC is 5.08% and 7.48% for a Home Equity loan. In contrast, private student loans rates are usually above 8% with an excellent credit cosigning parent.
2. Interest rate on a home equity loan is tax deductible for most parents.
There are a few exceptions: First, parents who are subject to the Alternative Minimum tax are only allowed to write off the interest on loans used to buy or improve a home. Second, borrowers who take out a home equity loan that along with their first mortgage raise the debt to a level above the value of the property can deduct the interest on only part of the home equity debt. It is determined by subtracting the amount borrowed to acquire the property- the first mortgage- from the fair market value of the home and only that amount can be tax deductible.
3. Lower fees than private student loans
HELOCs usually have no application fees and minimal annual fees. In comparison, private student loans charge a fixed percentage of the loan amount as a fee which is determined the borrower’s credit score.
4. HELOCs are more flexible to repay.
HELOCs only require a borrower to pay monthly interest in the outstanding balance. A borrower can usually repay as much or as little for up to 10 years. Repayment on some private student loans is not required while the student is attending school; however, interest usually accrues from the second the loan is taken out.
With that said, it is very important to understand the difference between home equity loans and a HELOC. A HELOC is like a debit credit account where instead of taking out a lump sum, you have a line of credit where you can take out small amounts of money at a time. Below are important points to know before pursuing either one of these alternatives:
1. Impact on eligible financial aid: A home equity loan will have a negative impact on the amount of financial aid you will get from the school. The lump sum you take out will be factored into the need analysis formula for FAFSA. However, with a HELOC, this problem does not occur since you will only use the line of credit when you need to pay bills.
2. Interest rates: A home equity loan has a fixed interest rate; however, a HELOC’s interest rate is variable. As always, the interest rate is important because this affects the “cost” of the loan. Currently, a $30K HELOC has a lower interest rate than a $30K home equity loan so just because the rate is variable doesn’t mean it is higher. It’s just not fixed.
3. Owing more than the house is worth: With the unpredictable housing market and economy, there is a big chance that you may end up owing more than your home is worth. You may borrow less than your house is worth at the current market value but in a few years, in a declining market, the house might be worth less. A home with negative equity will make it hard to sell in the future.
4. Self-control: With HELOCs, you can take out just what you need instead of having a huge chunk of cash in your bank account that for some might be quite tempting. Either way, it is important to understand that this not your money. This money needs to be paid back so it is important to spend only what you need and not buy any extraneous or luxury items while you are in college.
It’s important to evaluate all these pros and cons. Remember, the best decisions are made with careful thought. “Measure twice, cut once.”
