Ask anyone: college is expensive. As tuition rises, families need to plan ahead for this major expense. Even if your child is eligible for need-based student loans, those funds might not cover the entire cost of tuition, books, and housing. In either case, you might want to explore a strategy that employs multiple funding options. Most families will rely on a blend of financial strategies to help their children pay for college. A home equity line of credit (or HELOC) is one of these tools. Cash-out home refinancing is another. We’ll walk you through the pros and cons of some of the financial tools in your college funding toolkit.
Assess Your Financial Needs
Even if you don’t think your child will qualify for financial aid, you should still fill out a Free Application for Federal Student Aid, or FAFSA. The FAFSA will tell you what your “expected family contribution” to your child’s tuition will be. Filling out a FAFSA does not mean that you need to accept any of the loans that are offered, but it’s a good place to start. Most university websites will provide an estimate for the cost of a full year, including tuition, books, housing, and meal plans. Weigh that cost against your expected family contribution, and you’ll have a rough estimate of the gap between available financial aid and the actual cost of sending your child to college.
The good news is that families have more than one option for obtaining federal financial aid. With government loans, it’s important to look at the interest rate and fees. Currently, unsubsidized loans accrue interest at about 5.28% and PLUS loans at 6.28%. It’s important, too, to consider the burden of student loans on new graduates. The average undergraduate matriculates with about $30,000 of debt. The required payment on that amount could make a big difference in your child’s life once they graduate.
Consider Other Financial Tools
If you want to help your child avoid taking out loans, or you intend to help pay for college using the popular “blend of financial tools” strategy, a HELOC or cash-out refinance might be a good option for you. If you have equity in your home, you don’t have to wait to sell your home. You can access that equity right now. As with federally provided financial aid, there are pros and cons to each type of financing.
HELOC
When you take out a HELOC, you’re using the value of your home as the basis for financing. If you’re approved for a HELOC, you can usually borrow up to 85% of your home’s value. So, if your home is $200,000, you could potentially borrow up to $170,000. This contribution could prevent a large loan balance for your child once they graduate. It could also provide an opportunity to consider a wider array of college options.
There are several advantages to a HELOC. Firstly, since it’s a line of credit, you can pull out cash whenever you need it within the draw period (usually between 5 and 10 years). This may be a perfect solution for parents who intend to help their child pay for books, housing, or other necessities as they arise.
Secondly, HELOCs do not require payments on the principle of your loan for the length of the draw period. You are only responsible for interest payments during that time. Delaying payment on the principle of your loan could help ease the financial burden on your family while your child is in school.
There are disadvantages as well. The biggest risk? If you default on your loan payments, you could lose your home. The second thing to consider is the interest rate. HELOCs have a variable interest rate, which means it rises and falls as the market fluctuates. Interest rates on HELOCs, however, are often lower than those attached to federal financial aid. You also have a much longer period to pay back the loan than with most government-backed college financing options.
Cash-Out Refinancing
Cash-out refinancing requires a bit more work but provides you with a lump sum. A cash-out refinance replaces your home loan with a new, larger loan and lets you pocket the difference. A lump sum could be useful if you’ve decided to pay your child’s tuition up front or to allow them to participate in the long-term budgeting process.
A cash-out refinance is a good choice if you can secure better terms on your new loan than on your old loan. For instance, if interest rates have gone down since you arranged your first mortgage, you have the opportunity to lock in a better interest rate for yourself. You also have the opportunity to start a new repayment term. For example, if you have 25 years left to pay on a 30-year mortgage, you could start a new 30-year term.
It’s good to be aware that a cash-out refinance is a process similar to buying a new home. That means it requires documentation, fees, and processing time. It’s also important to assess your equity. Most cash-out refinances are capped at an 80% loan-to-value (LTV) ratio. If your home is worth $250,000, and you still owe $100,000, that means you have $150,000 in equity.
Let’s say a year’s tuition is $30,000. Your cash-out refinance would leave you with $30,000 in cash for tuition and would replace your $100,000 home loan with one for $130,000. You wouldn’t be able to borrow more than $200,000, or 80%, of the $250,000 value of the home. However, if you’re able to obtain a lower interest rate, a cash-out refinance may benefit you financially while also providing funding for your child’s future.
Every family’s needs are different. Consider all the available tools in your college-funding toolbox—and keep those interest rates in mind. If you’d like more information, be sure to contact someone who can answer all your questions—such as the home loan experts at Solarity Credit Union—to make sure you have everything you need to give your child and your family a bright future.
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