Here’s Why You Shouldn’t Pay Off Your Student Loans With Equity in Your Home
Imagine a world where you can turn the equity in your home into a huge student loan payment.
That world exists, thanks to a new financial product offered by Fannie Mae, who, along with Freddie Mac, are the two financial companies responsible for backing many of the mortgages in the United States.
Basically, Fannie Mae will allow you to refinance your home and then use the equity you get from that refinance to pay off some or all of your student loans. It seems like a dream scenario for the millions of homeowners who also have student loans.
Fannie Mae sent out a press release about this groundbreaking product back in 2017, noting how much of a help it can be for homeowners who are struggling their way through mortgage and student loan payments.
“We understand the significant role that a monthly student loan payment plays in a potential home buyer’s consideration to take on a mortgage, and we want to be a part of the solution,” Fannie Mae Vice President of Customer Solutions Jonathan Lawless said in the press release.
The student loan mortgage swap, as it’s known, is part of three products that Fannie Mae released this past year.
How the Student Loan Mortgage Swap Works
Before we get into exactly how this mortgage-based product works, you have to know if you’ve got a Fannie Mae mortgage.
The easiest way to find out is to go to KnowYourOptions.com and use the site’s Loan Lookup tool. You’ll have to provide your name, address and the last four of your social security number.
Once you confirm that you’ve got a Fannie Mae mortgage, then you can work through the checklist of requirements to find out if you’re eligible for the mortgage swap.
Here’s a list of requirements, per Fannie Mae’s website:
- You need to have already paid off at least one of your student loans
- You have to be the sole payer on your loans
- The cash from your refinance has to cover a loan in its entirety
- You have to meet loan-to-value (LTV) requirements
The LTV requirements range from 70%-97%, depending on what kind of property you want to refinance.
Now, before we get into the general pros and cons of the student loan mortgage swap, it’s important that you know what a cash-out refinance is.
Say you have a home that’s worth $250,000 and you have $200,000 left on your mortgage, fees and interest included. Your equity in the home is $50,000.
Now, let’s say your interest rate is 7% and you want to refinance to lower it to 4.5%; this is common. Why pay a higher interest rate if you can qualify for a lower one and, therefore, lower monthly payments?
The cash-out refinance shakes up this thinking a bit by adding some of your equity to your new loan balance. So, you might do a cash-out refi and have a balance of $225,000 to repay instead of the $200,00 we mentioned earlier.
Some would argue this is a great way to get some extra money to do renovations and increase the value of your home or to pay for high-school grad’s college costs.
Fannie Mae came along and proposed a new idea – don’t pay for renovations, pay off your student loans.
The upside, of course, is that, if your interest rate is lower on your refinanced mortgage than what you’re paying on your student loans, then you win out because your new rate is lower than both your old mortgage rate and your student loans.
However, there’s one huge “flaw” to this student loan mortgage swap. When you have student loans, the government can’t come after a physical asset if you decide to default on your loans and not pay them.
The government may garnish your wages, reduce your disability benefits and/or take your tax refund. They can send a collections agency after you and, according to CNBC, they can even sue you for your outstanding balance.
When you do a student loan mortgage swap, you’re exchanging that student loan balance for a mortgage balance, you are now putting up your house as collateral. This is a crucial shift in liability.
Whatever dollar amount you cashed out from your equity to pay for your student loans is now leveraged against ownership of your home. If you don’t pay your student loans, the government can’t take your home.
If you use your home’s equity to pay off that balance and you don’t pay your mortgage, the lender can come after your house.
In the conversations I’ve had with financial professionals about this particular financial product, I’ve heard the same warning over and over again: “You’re turning a debt not tied to your home into a debt tied to your home. Tread carefully.”