Rolling Your Student Loans Into a Mortgage: Smart or Risky?
Student loans have become a collective burden for Americans. Across the country, 44 million people carry student loan debt, with an average balance of roughly $40,000. The burden is shared among generations as well. According to the Consumer Financial Protection Bureau (CFPB), student debt quadrupled among people 60 and older between 2007 and 2017, both because borrowers are carrying greater amounts of debt for longer periods and parents have cosigned student loans or borrowed on behalf of their children.
If you’re among the 44 million saddled with student debt and you’re a homeowner, you may be wondering if you can leverage the latter to pay off the former. While you can roll your student loans into your mortgage via a cash-out refinance or home equity product, doing so is very risky. You may also be able to accomplish many of the same things by refinancing your student loans or taking advantage of federal student loan benefits.
Here’s why rolling your student loans into a mortgage is a bad idea:
Con #1: You’re jeopardizing your home.
Student loans are unsecured debt, which means they’re not backed by any assets the way a mortgage or car loan is. A mortgage, of course, is tied to your home. When you increase the amount owed on your mortgage and extend the life of that loan, you also increase the risk of not being able to repay it and losing the home.
“The biggest con is that you’re converting unsecured debt to secured debt,” said Martin Lynch, compliance manager and director of education at Cambridge Credit Counseling Corp. in Massachusetts. “If it’s a modest balance, it may not stretch the mortgage that much and the math may make sense.”
However, he added, “It’s just the unforeseen that you have to worry about. You’ve imperiled the home” by adding more debt to it, he said. If you’re in a financially secure situation where you expect to remain in the same job or are confident of your income remaining the same, you may decide the risks aren’t significant enough to maintain the status quo. But there are no guarantees, even in seemingly stable positions.
Linda Jacob, a financial counselor at Consumer Credit of Des Moines, Iowa, concurred with Lynch. “My first question inclination is, why would you change unsecured debt and turn it into secured debt? For the federal loans, the worst you could lose is your tax return. Now, all of a sudden, you’re putting your house on the line, so you have to weigh that factor.”
Con #2: You may pay more interest over the life of the loan
Even if you get a lower interest rate than you’re currently paying on your student loans, an extended repayment period can mean you ultimately pay more interest. You’ll want to make sure that those numbers work out and that if they don’t, the other benefits outweigh the extra costs.
“You have to weigh it against the time. Increasing the time so much to pay 4% over 30 years can cost you way more than paying 6% over 10,” Jacob said.
Con #3: Interest rates may rise.
Depending on how you roll your student loans into your mortgage, you may find that the lower interest rate you receive today doesn’t work out for you long term. If you refinance with a variable-rate mortgage or take out a home equity line of credit (HELOC), your monthly payments — and therefore overall balance — could go up as interest rates fluctuate.
Con #4: You’ll forfeit federal student loan benefits.
Federal student loans include access to a number of repayment options, such as income-based repayment plans and public service loan forgiveness. There are also options for requesting forbearance or deferment agreements if you’re temporarily unable to make payments. You can also consolidate your loans through federal programs without losing the other advantages. When you incorporate those loans into your mortgage, you lose access to those benefits, which is why it’s higher risk.
Marguerita Cheng, a CFP and CEO of Blue Ocean Global Wealth in Maryland, shared that when she had a client who was $110,000 in debt on her student loans, she advised against using a HELOC or refinance to pay them off because of the federal loan benefits. The client ended up seeing nearly $80,000 of her debt forgiven through a federal loan forgiveness program, which would not have been available to her had she used her mortgage to pay off the debt.
You may also be able to deduct up to $2,500 in student loan interests on your taxes, and you would be giving that benefit up as well.
“It comes down to doing a lot of work with the calculator to make sure you’re not missing anything,” Lynch said.
Con #5: You may have to pay closing costs.
Whether you take out a home equity loan or HELOC, or you decide to do a cash-out refinance, you may have to pay closing costs that include appraisal, origination and attorney fees, among other expenses. These can add up significantly depending what your lender charges and whether they’re willing to waive any of these fees, and they may negate the benefits you expect to receive as a result of combining your student and mortgage debts.
Pro #1: You may secure a lower interest rate.
The interest rate on federal subsidized and unsubsidized loans for undergraduate studies is 5.05%, and it’s 6.6% for unsubsidized loans for graduate and professional studies. PLUS loans, which include parent, graduate and professional loans, currently have a 7.6% interest rate.
By comparison, the average interest rate on a 30-year, fixed mortgage was 4.94% as of mid-November. Fifteen-year mortgages were at 4.36%. If you can refinance your mortgage and get cash to pay off your student loans, you may be able to reduce the interest you pay on the student debt. You’ll still be making payments on it via your mortgage, but you could save thousands of dollars by moving from a 7.6% interest rate to 4.7%, particularly if you still owe a significant sum.
However, you may also secure a lower interest rate on your student loans by refinancing them with a private lender if you qualify. Refinancing your student loan with a private lender doesn’t put your home at risk.
Pro #2: You may be able to lower your monthly payment and extend the repayment period.
If you’re able to qualify for a lower interest rate, your monthly loan installments will decrease, increasing your overall cash flow. You can also extend the repayment period, which eases the burden further. For someone who is on a 10-year repayment plan for their student loans and is struggling to keep pace with that arrangement, shifting to a 20- or 30-year term on a refinanced mortgage could provide much-needed financial breathing room. Again, this is something you can accomplish by refinancing your student loans to a longer term, which avoids putting your home at risk. Remember, the longer you extend your student loan payments, the more interest you will pay over the life of the loan.
Pro #3: You can stabilize a variable rate loan into a fixed rate.
Although federal student loans have fixed interest rates, private student loans are often variable-rate products. With interest rates on the rise, refinancing or taking out a fixed-rate home equity loan can help you secure a consistent rate. Knowing how much you’re going to pay each month – and that the number won’t fluctuate based on the rate environment – can help you budget for the foreseeable future.
However, the vast majority of student loans are federal student loans with fixed interest rates. You can also refinance to a fixed rate with a private student loan company.
Pro #4: You can simplify your debt.
Perhaps making hefty student loan payments and mortgage payments each month seem unwieldy to you, especially if you’re also paying other debts. Rolling your student debt into the mortgage allows you to clear the former account and streamline your monthly payments – while also potentially taking advantage of the lower interest rate and decreased installment amounts.
Keep in mind you can also consolidate multiple student loans into a new, single student loan by refinancing. You’d still have a mortgage payment and a student loan payment, but you’d accomplish your goal of streamlining your debt without putting your home on the line.
How to do it
If you want to take the risk and roll your student loans into your mortgage, you’ll first and foremost need to have enough equity in your home. You’ll also need to meet standard loan criteria such as a good credit score and a favorable debt-to-income ratio.
If you have these factors in place, there are a few different options available:
In a cash-out refinance, you’re essentially replacing your existing mortgage with a new loan. The new mortgage includes the remaining balance from your previous loan, along with however much you’ve chosen to borrow against the equity you have in the house. You can take the difference as a lump sum and use it to pay off your student loans.
Home equity loan
With a home equity loan, you’ll borrow a lump sum based on the equity you have in the house and can apply the proceeds to your student debt. An advantage of the home equity loan is that you can get a fixed interest rate, which reduces uncertainty and insulates you from interest rate spikes.
Home equity line of credit (HELOC)
Rather than receive a lump sum, you have some flexibility in how you use a HELOC. You can use the entire amount to pay down the loan, or you can use some of the available credit while leaving a portion of it open for emergencies and other expenses. Remember, however, that these are often variable-rate products, so be mindful of how interest rates might impact your payments.
Fannie Mae student loan cash-out refinance
Fannie Mae, one of the leading government-sponsored enterprises that back conforming mortgages, offers a student loan cash-out refinance option for borrowers and cosigners willing to use their home equity to pay down student debt. The program stipulates that the refinance proceeds must be used to pay off at least one student loan and that the payment must be made when the loan closes.
The program was designed not only for student borrowers but for parents who borrowed on behalf of their children or who cosigned their kids’ loans. The latter groups may have a good amount of equity in their homes that they can use to refinance to a lower rate, giving both them and their children a break on the payments. The primary borrowers are still responsible for the loan, but if they have cosigners willing to work with them, the Fannie Mae program could alleviate the strain on everyone involved.
The bottom line
Rolling your student loan debt into a mortgage is extremely risky because you are putting your house on the line. If you are considering this option, the two most important factors to weigh are the interest rate you’re currently paying on the student debt and the size of that debt. Those numbers will be the starting point for determining how much you stand to save by incorporating your student loans into your mortgage.
But your personal financial situation and risk tolerance will influence the choice as well. If you’re confident that adding that to your mortgage won’t significantly jeopardize your home, it may make sense for you. At the other end of the spectrum, someone who owes $100,000 or more in student debt and has a 6% interest rate may decide the savings potential in a refinance or home equity product are worth it, even with the increased risks mentioned above.
Because the risks are so great, the decision requires careful consideration and a lot of math, so speak with your mortgage lender, a financial adviser or a credit counselor. They’ll be able to help you see the possibilities from all angles and inform you on the potential risks and benefits.
Student loan debt can feel like an enormous burden, and it’s understandable that you want to reduce it however you can. However, tying that debt to your house could create serious hardships for you and your family if you’re unable to make the new mortgage payments. Make sure you’re clear on the consequences before rolling unsecured debt into your home.