According to Business Insider, student debt in the United States is over $1.3 trillion and more than 70 percent of college graduates have student debt. When you combine student debt with mortgage payments and all other daily expenses, many consumers feel overwhelmed. Rather than making multiple payments per month, driving yourself crazy to keep track of them, you can use a cash out refinance to clear student debt from your monthly obligations.
The Loan-to-Value Ratio
A cash out refinance requires you to have equity in your home. This is the first step. If you opt for a conforming loan backed by Fannie Mae, the maximum loan-to-value ratio equals 80 percent. This means that your outstanding mortgage principal plus your student loans cannot equal more than 80 percent of the value of your home in order to take advantage of the refinance program.
The good part about the 80 percent maximum is you will not pay private mortgage insurance. This could save you even more money on your mortgage. The bad news is you have to have a high enough value in your home and/or enough of the principal of your mortgage paid down in order to qualify.
The Interest Rate
Another factor to pay close attention to is the interest rate offered on the cash-out refinance. Student debt might seem overwhelming and expensive when you look at the payments, but what is the interest rate that you pay? If your student debt interest rate exceeds the current offering on a cash-out refinance, you can make out on the deal. The opposite is true, however, if the cash-out refinance has a higher interest rate than your current student debt.
If you have multiple student loans, you can take an average of the interest rate to determine if you would benefit from a refinance. You should also work out the scenario for each situation. Lay out the possibilities including:
- Cash out refinance consolidating all student debt
- Keeping your original mortgage and adding a home equity loan to pay off student debt
- Keeping the mortgage and student debt as is without a refinance
When you lay out the monthly payments along with the monthly interest charges, you can determine which loan will cost you more in the long run.
The Tax Benefits
Many taxpayers can deduct the interest on student debt as well as their mortgage on their tax returns. Student debt, however, carries more restrictions. If you deferred your loans or if you make more than $80,000 per year, you might not be able to deduct the interest on your student loans. This makes the mortgage consolidation look more enticing as there are no rules against how much income you can make and still deduct your mortgage interest. This can help your bottom line in the long run.
What to Look for to Clear Student Debt
If you want to clear your student debt, you need to consider all of your options. The largest factor is the interest rate, but other things to look at include:
- Closing costs
- How much time the mortgage adds to your student debt
- If you can comfortably afford the new payment
Remember that a mortgage payment holds your house as collateral. A student loan, on the other hand, does not have any collateral. If you default on the student loan, you do not lose your home. You default on your mortgage, however, and you could lose your home.
Before you refinance with a cash-out mortgage, make sure you can afford it. Look at all sides of the equation. What are the closing costs? How long will it take you to break even on your closing costs? You can calculate this by determining exactly how much the new mortgage costs as well as exactly how much money you will save each month by consolidating your loans. Take the total cost of the loan and divide it by the monthly savings to see how many months it will take you to break even. If you will stay in the home longer than that break-even point, consolidating can work to your benefit.
Is refinancing your home the right choice for everyone with student debt? Probably not, but it can help a large majority of the 70% of Americans that are currently in debt with student loans. If you are in any type of financial trouble or anticipate difficulty getting your mortgage paid, however, it is not the best choice. Consider all of your options and look ahead at your future to determine if you can keep up with the mortgage payments. Student debt can be deferred or a payment arrangement worked out before the lender writes your loans off. Mortgage loans are not as forgiving. Understanding your career path and how you think it will pan out can help you make the decision to clear student debt that is right for you.