In college, I suggested we do one budget story near the beginning of my tenure at the student newspaper, and from then on, I was assigned all things math and money. As the finance guy, that meant every year I would go to the meeting where they decided what the next year’s tuition was going to be. Even at public institutions like the one I attended, tuition only seems to go up each year.
While that college experience and those stories I wrote played a huge role in where I am today, I also can’t help but feel I’ve had a front-row seat to exactly how Americans have racked up over $1.48 trillion in student loan debt. The average student loan debt among the class of 2017 was $39,400, up 6% from the previous year.
The situation isn’t great, but in certain cities, it’s been revealed this situation is even more serious. A recently released study compared student loan debt to mortgage debt among borrowers that had both across America’s 50 largest metro areas. In six of these areas, the balance on student loans was actually higher than the mortgage debt load people were taking on to pay for homes.
With that much debt out there, it makes sense that you would want to pay as little interest as possible. If you have high balances, it can make a lot of sense to try to consolidate those debts at a low rate. Since mortgages typically offer some of the lowest rates you can get for any loan, you can take a look at paying off your student loans by using your existing home equity to get cash out. This article will take a look at the problem and how debt consolidation could help. We’ll also highlight at least one special option that could save you money.
Breaking Down Student Loans
There are several different types of student loans you can have, and the type determines the rate you can get as well as the amount of debt you end up accumulating.
The federal government offers a couple of different types of student loans: subsidized and unsubsidized. Both loans share the same fixed rates, but on subsidized loans, the federal government pays the interest while you’re in college. Although you’re not required to make a payment on any of your student loans through the federal government until after you graduate, if you get an unsubsidized loan, the interest builds over time. If you don’t make the interest payments while you’re in college, they’re added to your principal balance when it comes time to repay the loan, so the debt can build faster.
Some students also turn to private student loans. There are a couple of reasons for this. Qualifications for federal student loans are need-based and come with an expected parental contribution based on household income. Based on a parent’s perceived ability to pay, the amount of federal student aid may be reduced if it’s not cut off altogether. However, because parents may be unwilling or unable to make that contribution, students may have to turn elsewhere.
There may also be limits on the number of direct federal student loans someone can get. Every situation is different.
If you turn to private student loans, you might be able to find fixed rates anywhere between the low 4% to just above 13%. You can get slightly lower starting variable rates, but these will fluctuate with the market.
The Benefits of Debt Consolidation
If you have a significant amount of student loan debt, rates as high as 13% mean you could end up paying a ton in interest. There’s a better way.
Interest rates are typically on the very low side for a mortgage in comparison to other types of loans including those available for students. The Federal Reserve has given indications that interest rates should remain low in the near future absent a major change in economic data.
If you consolidate debt with your mortgage, rates right now are in the high 3% – low 4% range on a 30-year fixed loan. Your rate is dependent on a variety of financial factors.
If you choose to get an adjustable rate mortgage1, the initial rate will be lower than anything you can get in a fixed rate for a comparable term. Although this will eventually go up or down with market movements, for a period at the beginning of the loan that’s typically 5, 7 or 10 years, you’ll have a low fixed rate. You can take advantage of that time to pay down the principal so you pay less in interest even if you don’t sell the home or refinance into a fixed rate at the end of the initial teaser period.
You do have to leave a certain amount of equity in your home if you want to take cash out, so it’s important to do some math upfront to make sure it makes sense for you.
If you have an FHA or conventional loan, you’ll need to leave at least 20% equity in your home following the close of your cash-out transaction a 1-unit primary property. Multiple units may require more equity depending on the type of loan you’re getting. Therefore, you’ll want to make sure that the amount of equity you’re converting into cash will still be enough to cover paying off the desired student loan balances.
The notable exception to this equity restriction is for a VA loan, where you can borrow up to the full value of your home if you have a median FICO® of 680 or higher. If your median score is 620 or higher, you’ll have to leave 10% equity in the home. However, to qualify for a VA loan, you have to be an eligible active-duty service member, veteran or surviving spouse. If the VA loan is available to you, it offers some great benefits.
Before closing out this article, we wanted to take a second to highlight a special program from Fannie Mae for those looking to use home equity to pay off student loans.
Get Rate/Term Rates When Consolidating Student Loans
Typically, when you refinance to take cash out, your interest rate is slightly higher than if you”re doing a refinance to lower your interest rate or change your term. Mortgage investors consider cash-out refinances to be slightly riskier. However, conventional mortgage investor Fannie Mae offers rate/term pricing for those taking cash out to pay off student loans.
In order to take advantage of this deal, you have to meet a couple of conditions:
- At least one client on the loan has to be obligated to pay off student loan. You couldn’t pay off student loans that are only in the name of your son or daughter, for example.
- You must be paying off at least one student loan in full.
- Other than the student loan, you can’t pay off any additional debt in the transaction.
The lower rates associated with rate/term transactions mean you could save money over the life of the loan when comparing it to a traditional cash-out refinance.
If you think a cash-out debt consolidation is right for you, you can apply online with Rocket Mortgage® by Quicken Loans. You can also get started over the phone by speaking with one of our Home Loan Experts at (800) 785-4788. If you have questions, you can go ahead and leave them for us in the comments below.
1As of April 20, 2020, Quicken Loans® isn’t offering conventional adjustable rate mortgages (ARMs).
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