The student loan crisis in the US has reached critical mass. There are approximately 44 million borrowers in the country who owe at least $1.6 trillion in student loan debt. The only debt that people owe more of is home mortgages.
Amazingly, the amount Americans owe on student loans is higher than auto loans or credit card debt. That’s quite an achievement, given how Americans love to buy cars and other possessions on credit.
But Fannie Mae decided recently to offer student debt holders a chance to reduce the interest rate on their student loan debt. The government-backed mortgage company is offering student loan cash-out refinances for student loans. The new mortgage program allows borrowers to utilize some of the equity in their homes to pay off their student debt.
This sounds like a tempting offer. Who doesn’t want to reduce their interest rate on student loans and lower their monthly payment? And as of March 2020, cash-out refinance rates for 30-year fixed mortgages averaged 3.75%.
Hold your horses. It is critical to know that many financial experts say that doing a cash-out refinance to pay off your student loans may not be a good idea for everyone. With the benefits, there are downsides.
Let’s dig into the details of this Fannie Mae program to determine if it’s a good move for you.
How Cash-Out Refinance for Student Loans Work
The Fannie Mae program allows homeowners to use home equity to pay off one or more student loans. This may reduce your monthly student loan payment.
The special offer hinges on what is known as a loan-level price adjustment. This is a risk-based fee assessed to the home loan borrow on a cash-out refinance; this usually comes in the form of a higher rate. This adjustment can be waived if you are using your equity to pay off student loans.
For example, the rate for a 30 year fixed, cash-out refinance in March 2020 is roughly 3.75%. But for a 30-year fixed purchase mortgage, the rate is 3.45%. That adjustment waiver can significantly lower your student loan payments in some cases.
Want to qualify for this program? You need to pay off at least one student loan with the refi. Also, the money must be paid to your student loan servicer at the closing table.
But Should You?
This program might be a good move, but it is critical to look at the risks, too. Consider these risks:
#1 Your House Is Collateral
The first downside is you are putting a lot of your debt into one place – your home. You are making your home the collateral for your student loan debt.
If you are unable to pay your student loan debt, you will damage your credit. But if you don’t pay your mortgage, you will damage your credit AND lose your home. This may not be worth the risk for many people.
Also, experts note that you will pay more interest over the years when the debt is refinanced into one big sum. It also takes longer to pay off your loan because your mortgage amount increased.
#2 You Lose Protections
A nice thing about federal student loans is if you get fired or laid off, there are several programs to help you. You may be able to qualify for an income-driven debt repayment program. In serious cases, some borrowers can defer their loan payments for a certain period.
If you roll your student loans into your mortgage, those protections go out the window. If you get laid off and cannot pay your mortgage, you have few options available.
Also, by wrapping your student loan debt into your home loan, you no longer can get help from employer-assisted repayment of your debt. Further, you cannot qualify for loan forgiveness, which is a possibility for teachers, some public service workers, and a few others.
#3 You Are Lose Equity
Putting student debt on your mortgage eats into the equity you have spent years building. That’s a big negative. If you pull out cash after paying for years on your loan, you are largely starting over on the mortgage (unless you opt for a shorter mortgage term).
Putting tens of thousands of dollars of student loan debt into your mortgage will increase what you owe on your home. If your finances hit the skids, you still have to pay your home loan or the bank comes knocking at your door.
With more debt on the mortgage, you may struggle to make the payments when you hit hard times.
#4 You Lose Tax Deduction Possibilities
Fewer people are itemizing their deductions on their tax returns, including mortgage interest, given the tax law changes that began in 2018. But student loan debt can still be written off! And it does not matter whether you itemize or not. But if you do a cash-out refinance for your student loans, you lose this benefit.
Remember, your student loans are an adjustment to gross income and will lower your taxes. You lose this benefit with a cash-out refinance.
Final Thoughts on Cash-Out Refinance For Student Loans
Refinancing your first mortgage to pay off student loans has risks and is not for every borrower. But for some, it can be a solid financial option.
For example, if you struggle to make student loan payments every month and can reduce your rate significantly, you may want to pull the trigger on the refi. However, take a close look at your finances and your future plans before you call the mortgage broker.
If you do the refi, you should have lived in the home for several years. Say you get a new job in another town and have to sell, but housing prices crashed. You could be upside down and unable to sell because you took on more debt.
If you have at least 50% equity in your home, the risks are lower; even if housing prices plunge, you might still sell the home and come out ahead.
So, take a look at what Fannie Mae is offering and see if you are eligible. But go into the situation with your financial eyes wide open so you make the best decision.
- Student Loans Owned and Securitized, Outstanding. Accessed at https://fred.stlouisfed.org/series/SLOAS
- Selling Guide Announcement SEL-2017-04. Accessed at https://singlefamily.fanniemae.com/media/20191/display
- Mortgage Rates Are Near All-Time Lows as Coronovirus Worries Hit Markets. Accessed at https://www.npr.org/2020/03/02/811223836/mortgage-rates-are-near-all-time-lows-as-coronavirus-worries-hit-markets
- Income-Based Repayment Programs. Accessed at http://www.ibrinfo.org/what.vp.html