Should you use a HELOC to pay for your kid's college? What experts say
Today's high interest rate environment has led many borrowers to look for new ways to save. And, one option that could make sense in today's high-rate environment is a home equity line of credit (HELOC), which is a line of credit tied to the equity in your home. By using a HELOC to borrow against your home's equity, you could get a lower interest rate than what's available from other lending options, like personal loans or credit cards.
Right now, the average homeowner also has a lot of tappable equity — or about $200,000 — to borrow from. And, as families look for ways to finance their children's college educations this fall, some are considering whether to use a HELOC to help cover some of those costs.
Using a HELOC to cover certain expenses might be a good idea, especially if you need to borrow money for home repairs or improvements, as there can be tax benefits to doing so. But a HELOC may not make sense for every purpose. For example, if you're thinking about using a HELOC to pay for your kid's college, here's what the experts say about it.
Find out what the best HELOC rates are that you could qualify for now.
Should you use a HELOC to pay for your kid's college? What experts say
Using a HELOC to pay for your child's college tuition and expenses could be a solution if you need access to a large amount to cover the costs — or if you're unsure how much you may need in total. That's because you can tap into a HELOC multiple times during the draw period (up to the credit limit), so you won't have to borrow a lump sum initially. That gives you some flexibility in terms of usage.
And, a HELOC also allows you to tap into a large portion of your home's equity. While the maximum varies by lender, you can typically borrow a maximum of between 80% to 85% of your home's equity. That gives you access to a large sum that may not be available with other types of loans or lines of credit.
That said, there are some downsides to consider, experts say. For example, while HELOC interest rates are lower than many other borrowing options right now, that doesn't mean that they'll always be cheaper. If rates change in the future, your HELOC could get a lot more expensive.
"HELOCs typically have an adjustable interest rate," says Rachael Burns, a CFP and founder of True Worth Financial Planning. "The payments may seem reasonable now, but if interest rates rise in the future, they can become unaffordable."
The main issue is that HELOC APRs are tied to the prime rate. So, when the Federal Reserve changes the federal funds rate, HELOC rates can go up or down in return.
"If interest rates go up from here, the HELOC rate [will] adjust higher accordingly," says Matt Faubion, CFP and wealth manager at Faubion Wealth Management.
And, HELOCs have a draw period that typically lasts about 10 to 15 years. While you aren't required to make payments on the principal during the draw period, you're still on the hook for making minimum monthly interest payments on your HELOC, which vary based on how much you use from your line of credit.
Another risk is that a HELOC is a type of second mortgage, which means your lender could foreclose on your home if you don't pay your HELOC. On the other hand, personal loans and credit cards are unsecured, so if you fall behind, your credit score will drop but you won't lose any assets.
In turn, it could be risky to use a HELOC for this purpose, Jaime Eckels, a partner at Plante Moran Financial Advisors, says.
"It's using the home as collateral for a loan, which puts the home at risk if the owner is unable to make payments," Eckels says. "It can be a bit of a gamble if the owner's financial situation were to decline unexpectedly and they are unable to make the payments."
It's also worth noting that the more you pay into your home, the more equity you build up. Taking out a HELOC means you're losing some of that equity.
"People rely on the equity in their home as reserve assets if they run out of money, need to buy another home, need to cover nursing home expenses and leave a legacy," says Craig Kirsner, MBA and president of Kirsner Wealth Management. "Taking out money to cover college costs can jeopardize some or all of those safety nets."
Explore the home equity tapping options available to you here.
Other options to consider
If you decide a HELOC isn't right for you, there are college-specific financing options that don't require using your home as collateral. For example, you may want to try to get scholarships and grants — including institution, state and federal options — before borrowing.
Student loans, whether federal or private, are another good option to consider before taking out a HELOC to pay for college, experts say.
"If borrowing is necessary, weigh the pros and cons of borrowing in your name [compared to] having your children take out their own student loans," Burns says. "Your children may have access to certain programs that are better than your own borrowing options."
"Federal student loans are the safest and most cost-effective option because interest rates are typically fixed on a federal student loan and may be tax deductible," Eckels says. "HELOCs tend to have variable interest rates and are not tax deductible when used for college expenses."
Parents with younger children may also want to consider setting up 529 or a similar college savings account.
"The best option for parents wanting to pay for their child's college costs is to set up a 529 plan," Eckels says. "Planning early and contributing over time allows the account to grow tax-free. And encouraging family and friends to contribute to the child's 529 plan can be a great gift alternative."
The bottom line
HELOCs can be a smart way to borrow for certain purposes, like making home improvements or repairs or even consolidating high-interest debt. However, they may not be the right solution in every case. For parents trying to pay for their child's college, a HELOC could make sense, but there may be other ways to cover school costs that are a better decision for your wallet.
