Should we pull equity out of our home to pay for college?

Question of the week: Should we pull equity out of our home to pay for college?

Answer:  Many families will be looking at options to finance tuition for their college bound children this summer, and every summer. Many homeowners, especially those in California, fall into the gap between qualifying for scholarships and financial assistance based on need due to earning too much to be eligible, and not earning enough to comfortably paying the ever-rising costs of college.

As a result, either college options change to reduce costs, or some borrowing is required. Assuming they have enough equity in their homes, many parents feel the need to use some of that equity to help pay costs for their children’s education to fill the gap.

Being the father of two college age children, and also having a bit of knowledge how debt and finances work, our family did a lot of exploring for options to pay for college. The least favorable options were, to us, using any home equity. For a few reasons, a few of which are given below, and primarily, it is our firm belief that students must have a strong financial stake in the cost of their pursuit of a degree to ensure accountability and add value to the work and result of their college experience.

Here are the primary options most families consider:

Cashout refinance: The advantage of this options is a fixed rate payment that is relatively low due to being amortized for 30 years. There are two primary disadvantages to using a long-term fixed rate mortgage. First, you are paying for college costs for 30 years, or until you sell the home; if you refinance later, you are extending the time you make the payments. Second, let’s suppose the amount of money you will need to borrow for four years is $60,000. With a standard refinance you will borrow all $60,000 and then use $15,000 in year one, $15,000 in year two, $15,000 in year three and the final $15,000 in year four. While it will be four years before you use all the money, you have to pay for it at month one.

Equity line of credit: The primary advantage of obtaining a HELOC is you only pay for the amount of money you borrow. Using the example above, in year one you access $15,000 and only pay interest for the $15,000 outstanding balance. As the years go by, depending on how you manage payments, the highest balance you will have is $60,000 but you will not pay for that amount until it is needed and borrowed. Another advantage of most HELOCs is flexible payment options, as many have a minimum payment of interest only. A disadvantage of the HELOC is the rate is adjustable and over time will likely be higher than it is today. One additional advantage I have seen for some families is that while their student is in college, the parents may make the interest payments, when their son or daughter get a job they repay their parents monthly to pay down the loan.

Federal student loans: These loans have a few options that you don’t get to choose, but are offered to you depending on your financial profile. These loans are either offered to students or to parents depending on financial need based on parent’s income; as well the college or university determines how much you are eligible to borrow. If your student qualifies for a “Direct Subsidized Loan” the U.S. Department of Education pays the interest while the student is enrolled at least half-time and for the first six month after leaving school. The other standard type of loan is a “Direct Unsubsidized Loan” and interest is paid by the responsible party; this loan has the option of deferring interest while in school, however the interest accrues. Some students receive loans from both categories and must understand that one loan has interest that is accruing which will increase the amount of money they will owe when they leave school. The advantages of the federal loans are the payment subsidy for those who qualify, and deferred payments while the student is in school. The primary disadvantage is the low loan amounts available to most California homeowners due to the average income of most applicants from our region, resulting in many families needing other financing options to cover the cost – loan gap.

Private Student Loans: There are many of these loans available and offer a lot of flexibility. Typically, these loans have parents and student co-signing on the loan and have several advantages. They are offered for varying repayment periods, enabling the ability to choose longer terms for lower payments to make it easier for graduates to pay with their lower starting pay in the job force. Most lenders offer fixed or variable rate loans, depending on your risk aversion. Finally, it helps students build a credit history with assistance from parents. For parents a disadvantage is they are on the hook for the payments. If your student is out of job five years after graduating and stops making payments, either you make the payments or see the hit to your credit score.

Federal and private student loans are made per quarter or semester, therefore if a student graduates from a four year college attending three quarters per year, they will end up with twelve loans, or if using federal and private loans up to twenty-four loans. This is easily managed as the loan servicers usually consolidate all the payments on one statement (to be clear, all the loans of the same type with same lender will be consolidated for one payment statement).

After graduating, students have the opportunity to consolidate their loans through one of many private lenders. This allows for easier management of the student loan debt, and may result in lower payments and/or interest rates.

Discussions about how to pay for college are quite often the first financial education many young adults have. They are important conversations that can help students decide the value of the degree they seek, weighed against potential income after graduation to pay for the degree they earned.

In our home, our conversations began with how student loans work. We discussed how interest deferment works, and of course how much their payments would be after graduating. In our conversations, the girls learned how much would be contributed to their education and any costs above that would be student loans that would be their obligation to repay.

After looking at schools, costs and subsequent loans needed to cover their financial needs, I broke down what their monthly loan payments would be, added estimates for rent, added estimates for costs of living such as food, clothing and transportation, and then showed them the income they would need to make sure all their costs, including student loans, could be met. Note, not included in the conversations were living at home rent free.

In the end, we, like most families, have a mishmash of federal and private loans. For the private loan we went with a lender that has a one-time approval process that results in essentially a line of credit. Each semester the needed amount is funded against the total amount for which we were approved, with the girls co-signing on each loan. This reduces the amount of paperwork and effort we must go through each semester. One other factor I liked about the loans is that after graduation, when we can show that the girls have made all the loan payments for twenty-four consecutive months, Leslie and I are released from the loan obligation; thus, removing liability and from our credit record.

To answer our question of the week, yes you can use equity from your home to finance your children’s education; however, in my opinion a better option is to pursue other student loan options in which your children are at minimum equally responsible for the cost of their education.

Have a question? Ask me!

Today’s jobs report was much better than last month’s, though if it were not our economy would be in serious trouble; but still not as positive as many on Wall Street expected. May saw 559,000 new jobs added to the economy, more than double the number of new jobs from April, but almost 20% less than expectations. The unemployment rate dropped to 5.8%, that is likely reflective of many potential workers not seeking jobs, as evidenced by over eight million jobs still missing from employment levels pre-Covid. 

The jobs that were added are not enough to cause more growth. Leisure and hospitality created more than half the jobs in May, and employers paid more to get those workers back on payrolls as evidenced by the increase in average salaries. The majority of jobs created were at or near minimum wages rates, which should have seen average pay decline nationally, however reflecting what many business owners have been saying, they have raised wages to entice workers to forego on-going unemployment benefits that are super-charged by government stimulus funds.

As reported in MarketWatch, economists are indicating several factors that explain why many workers are not returning to work. Among these factors are many workers took early retirement during the pandemic, challenges finding child-care and generous unemployment benefits. Expectations are that these conditions will last at least until fall, coinciding with expiration of the unemployment benefits increase.

Rates for Friday June 4, 2021: Markets continue to see choppy trading on a daily basis, but trending upward over the past week. Rates remain flat again this Friday.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.75%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

Next week’s update may be a bit late and truncated as Leslie and I, along with my siblings, will be headed to Tulsa, where several generations were born, for a memorial service. It seems that the next several months will be filled with such remembrances for all of us as we have an opportunity to honor, bless and remember those who have passed away during the pandemic and services were unable to be held.

While sad events, they are also joyous in that they provide us the opportunity to see family and friends we have not been with in some time. An opportunity to shed tears and share laughs as we remember good times with those who have passed, and those who remain.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog