If you’re a homeowner and have student loan debt, you may be thinking about tapping into your home’s equity to pay down your college debt.
Mortgage rates are at unprecedented lows right now. According to Freddie Mac, the secondary-mortgage market leader, the average interest rate on 30-year mortgages was 2.87% as of October 2020.
Since student loan interest rates can range from 3% to 12%, refinancing your mortgage and using the extra money to pay down your debt can be appealing.
However, this strategy can be risky. If you’re considering using a mortgage refinance to pay off your loans, here’s what you should know first.
What is mortgage refinancing?
One of the ways to pay off student loans faster is to apply for a cash-out refinance mortgage. With this strategy, you take out a loan for an amount that is larger than what you currently owe on your existing home mortgage. You use the new cash-out refinance loan to pay off your current mortgage, and the difference is issued to you in cash. You can use the extra money for whatever you want, including paying down debt.
For example, let’s say you have $150,000 left on your mortgage and $30,000 of student loan debt. You could use your home’s equity to take out a $180,000 cash-out refinance loan — $150,000 to pay off the current mortgage and an additional $30,000 to cover your education debt.
Why you should never refinance your mortgage to pay down student loan debt
If you have student loans with high interest rates and are considering a mortgage refinance to eliminate your debt, you should know there are significant drawbacks to this strategy.
1. You have to pay closing costs and fees
Unfortunately, refinancing your mortgage isn’t free. You typically have to pay closing costs and fees, which can range from 2% to 5% of your loan amount. On a $180,000 cash-out refinance loan, that means you should expect to pay $3,600 to $9,000 in closing costs.
You can often roll that amount into the loan rather than paying it upfront, but by adding to your loan balance, you increase how much interest will accrue over time.
2. You have to use your home as collateral
While student loans can be frustrating to manage, there is one upside: they’re unsecured. Student loans don’t require you to use any property as collateral. Lenders can charge you late fees and send you to collections, but they can’t seize your home or valuables if you fall behind on your payments.
By contrast, mortgage refinancing loans are a form of secured debt. Your house acts as collateral. If you miss loan payments, the lender can foreclose on your home, and you could end up losing it. That’s why home loans are so much riskier than student loans.
3. You have to undergo a lengthy underwriting process
When you apply for mortgage refinancing, you essentially go through the same process as you did when you took out the original mortgage. The underwriting process is extensive and can take weeks to complete.
Student loan refinancing: A safer alternative to mortgage refinancing
While refinancing to get a lower interest rate is a good idea, mortgage refinancing is risky. However, there is a safer alternative: student loan refinancing.
With student loan refinancing, you apply for a loan from a private lender for the amount of your existing education debt. The lender reviews your income and credit score to determine an interest rate on the new loan. Depending on your information, you could qualify for a lower rate than you have now, and you can even adjust your monthly payment and repayment term.
Unlike mortgage refinancing, student loan refinancing is completely unsecured. You don’t have to put down any form of collateral, and there are no closing costs or fees. The application process is quick and easy; you can typically apply online and get a decision within minutes. If approved, your new loan can be disbursed within a few days.
Right now, interest rates on student loan refinance loans are quite low, making it a good time to consolidate your debt. By refinancing your loans, you could save a significant amount of money without risking your home.
For example, Matt has $30,000 in student loans at 6.5% interest and a 10-year repayment term. He refinances his loans and qualifies for a 10-year loan at 4.00% interest. By refinancing his loans, he is able to reduce his monthly payment, and he saves over $4,400 over the life of his repayment period.
| Original Loan | Refinanced Loan | |
| Loan Balance | $30,000 | $30,000 |
| Loan Term | 10 Years | 10 Years |
| Interest Rate | 6.5% | 4.00% |
| Minimum Monthly Payment | $341 | $304 |
| Total Interest | $10,877 | $6,448 |
| Total Repaid | $40,877 | $36,448 |
| Total Savings: $4,429 |
Should you use mortgage refinancing to pay off other debt?
If you have high-interest debt, such as credit card balances, car loans, or other forms of debt, a cash-out refinance loan can seem like a smart idea. You can get a much lower interest rate on a cash-out refinance loan, and use the money to pay off your other debt.
However, you should carefully weigh the pros and cons of doing this before applying for a loan. While you could save money, you’ll be moving debt from one form to another. If you don’t have a plan for repaying the debt, you could end up in a worse situation than you were before.
In general, it’s not a good idea to transfer unsecured debt to secured debt, as you risk losing your property.
How to find your best student loan refinance rates
If you have high-interest education debt, you may be wondering, “Should I refinance my student loans?” While a cash-out mortgage refinance can help you secure a lower interest rate, there are major drawbacks that make it not a good idea.
Instead, student loan refinancing is a faster, less expensive option that allows you to get a lower rate and save money. If you think that refinancing is right for you, use Purefy’s Compare Rates tool to get rate quotes from top refinancing lenders.
