5 reasons to think twice before doing this with student debt
If you're looking for a quick, low-cost way to pay off your student loans, you can find a few options. But while you may be able to consolidate or refinance (even private loans), you won't find many ways to significantly pay off those loans without forking over more money every month.
However, if you have home equity, a new route to paying down student loans is now open. Fannie Mae, the federal mortgage financing company, recently announced a new program that allows student debt holders to "swap student debt for mortgage debt."
The novel program permits mortgage "originators that sell loans to the mortgage giant to offer a new refinance option for the purpose of paying off a student loan. Proceeds from the refinancing will go directly to the student loan servicer to fully pay off at least one loan."
That means you can exchange student loans for mortgage debt. That will indeed erase your student loans on paper, but what you owe isn't magically eliminated. It's added on to your mortgage obligation. And it could boomerang on you if you can't pay your mortgage: You could lose your home.
Although you can often get a better rate on a home-equity loan than on most credit cards and installment loans, federal college financing is mostly pretty cheap. Federal student loan rates range from 3.76 percent (undergraduate) to 5.31 percent (graduate). They reset on July 1.
Private home-equity loans range from 4 percent to 7.6 percent, according to Bankrate.com. The higher your credit score, generally, the lower your interest rate. Credit card rates are averaging 15 percent, according to creditcards.com.
The one exception to the low-rate student rate offerings are PLUS loans, which parents usually take out, pegged at 6.31 percent for this academic year. Note to parents: Avoid these loans at all cost.
Still, the lure of rolling federal loans into a mortgage debt sounds tempting. But here are five major drawbacks you should be aware of:
- You lose flexibility from the federal student loan program. "Homeowners who tap home equity to pay off student debt give up their rights to income-driven repayment options on their federal student loans, which cap federal student loan payments at roughly 10 percent of their income," said Rohit Chopra, senior fellow at the Consumer Federation of America. "Income-driven repayment is a critical safeguard during periods of unemployment or other income shocks that help avoid the consequences of default." Also, keep in mind that the federal college loan program has multiple repayment options.
- You may not be able to have your federal student loan forgiven. This would apply to those in public service professions who may qualify for loan forgiveness after a decade.
- You may not net a lower rate on your "rolled in" debt. As noted above, student loans relative to private mortgage rates, can often be a better deal. "Federal Stafford Loans for undergraduate students have a low fixed rate, currently 3.76 percent," noted Mark Kantrowitz, publisher of Cappex, a college decision site. "They are unlikely to qualify for a lower rate on a mortgage."
- You lose federal loan breaks if you can't pay. The federal loan program has a surprising number of generous provisions if you're sick, disabled or can't pay back your loan. "Federal student loans offer significant benefits that aren't standard with mortgages, such as death and disability discharges, economic hardship deferments, forbearances, income-driven repayment plans and loan forgiveness options," said Kantrowitz.
- The tax treatment may be less favorable. The traditional wisdom over the years has been to favor mortgage debt over other kinds of credit because home-related debt is tax deductible. However, Kantrowitz pointed out: "There's a deduction for mortgage interest, but you must itemize (most taxpayers don't). The student loan interest deduction, on the other hand, lets you deduct up to $2,500 in interest on federal and private student loans. It's an 'above-the-line' exclusion from income, so you can claim it even if you don't itemize. It also reduces the [adjusted gross income], which may have other benefits."
While plenty of factors argue against doing a mortgage debt swap with your student loans, there's one exception, Kantrowitz pointed out:
"The only case in which a borrower might consider using a mortgage or home equity loan or line of credit to pay off student loans is if the student loan borrower has high-interest private student loans.
"They might be able to save money through refinancing. Though, generally, if they have a high interest rate, they might be able to get a lower interest rate if their credit score has improved a lot since they borrowed the money. If they don't qualify for a lower rate on a private consolidation loan, they're unlikely to qualify for a home loan with a lower rate."
The bottom line with student debt management is to be careful. Look at all of the scenarios carefully and see how much you can save -- if you can reap any savings at all.
