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For those keeping up with the Federal Reserve, their recent decision to keep interest rates low has affected a broad range of financial areas, from mortgages to your savings account. If you're carrying any form of debt, it could be worth exploring opportunities to reduce your rates.
With mortgage rates at all-time lows, you might be considering using your home equity to pay off higher-interest debt, like your student loans. This could be an ideal solution if you're eligible for a student loan cash-out refinance, which leverages home equity to eliminate student debt. Here’s what you need to know before proceeding with an application.
Understanding the Process of a Student Loan Cash-Out Refinance
If the value of your home exceeds your mortgage, you have home equity, which means you might be eligible to borrow against that equity for various purposes. A student loan cash-out refinance involves taking out a larger mortgage to pay off both your current mortgage balance and part of your student loan.
To be eligible for a Fannie Mae-backed student loan cash-out refinance, you must have at least 20% equity in your home and you need to pay off at least one student loan entirely during the process. (Fannie Mae’s full eligibility criteria—including acceptable credit scores and debt-to-income ratios—are available here.) Many lenders don't promote student loan cash-out refinances—although SoFi stands out as one of the notable exceptions. You can also compare options on popular mortgage comparison platforms.
Understanding the Risks of a Student Loan Cash-Out Refinance
One of the main risks of a student loan cash-out refinance is the potential to increase your mortgage balance. While you could secure a lower interest rate, this might lead to higher monthly mortgage payments. This is especially concerning during times of economic uncertainty, such as the pandemic. You may also be reducing the equity in your home, which could limit your future borrowing possibilities.
You should also factor in refinance closing costs and how long it will take for the savings to outweigh the costs of the transaction. If your student loan balance isn’t large, spending thousands of dollars on closing costs might not be worth it.
If you're one of the most creditworthy borrowers—boasting a high credit score, low debt-to-income ratio, and stable employment—you might want to consider safer alternatives, like refinancing your student loans directly. A key advantage of this option is that you won’t lose your tax deduction for student loan interest.
However, refinancing from federal to private student loans carries significant risks.
The Risks of Refinancing Federal Student Loans
When considering refinancing federal student loans, you should be aware of additional risks. For example, you might forfeit important borrower protections, such as the temporary pause on federal payments through 2020, or miss out on future deferment or forbearance opportunities.
Another major disadvantage is the potential loss of access to Public Service Loan Forgiveness or more flexible, income-driven repayment options. Given the stakes, you should weigh whether locking in a lower interest rate is truly worth it, especially amid economic uncertainty.
