After the initial excitement over the arrival of the acceptance letters, the reality of having to pay for college sets in. While there are many scholarship opportunities and other financial aid sources, there may still be a gap between what is needed and what you’ve saved and the school offered your child. Before you start borrowing under the federal parent loan programs—or look to private solutions—you may want to determine if tapping into your home equity might offer a better path for your situation.
Why This Could Make Sense
Your home equity has probably increased well above the amount you originally used as a down payment if you’ve lived in your home for a while. Between your monthly mortgage payment and the appreciation of homes in your area, you may just find yourself living in a piggybank.
Breaking into the piggybank to fund college is a big decision, but depending on your circumstances, it could be a more affordable one. It also could offer greater flexibility and control over how and when you repay the debt and make the interest you pay on the loan work to your advantage.
Under the current tax laws, mortgage interest is tax deductible for most borrowers. By contrast, interest paid on loans your child has taken out—and students can borrow more cheaply than their parents—that loan is not deductible for you even if you pay the interest. While interest on a Parent Plus Loan may be deductible, the deduction is capped at an amount lower than mortgage interest.
Tapping into Your Home Equity
There are three ways to tap into your home equity:
1. Cash Out Refinance. This option replaces your old mortgage with a new one with a higher outstanding balance. The additional amount is paid to you as cash. You can use these funds to pay for college or any other expenses you may have. It will restart the clock on repaying your mortgage, giving you a larger outstanding balance and potentially extending the years you have left on your debt.
2. Home Equity Line of Credit (HELOC). This type of financing offers you control over how much you borrow and when as it is a line of credit that you can access as needed, pay down, and borrow against again. The interest is tied to a benchmark—typically the prime rate—so it will fluctuate with changes in the market. For the first seven to 10 years, you are only required to pay interest each month, an amount that will vary with your outstanding balance and interest rate. At some point after that, the principal will need to be repaid.
3. Home Equity Loan. This is a second mortgage on your home. It’s typically made at a fixed rate. Like a conventional mortgage payment, it’s due monthly and represents both interest and principal on the loan.
These options should all be considered ahead of time. They need to be set up and, like a regular mortgage, there are costs involved with pursuing each one—often appraisals need to be done and your financial information needs to be verified. However, in the right situation, each may be a good after-tax alternative for helping your children pay for college in a more affordable and flexible way.