Those following the news from the Federal Reserve may know about their latest decision to keep interest rates low, which has impacted everything from mortgages to your savings account. If you’re carrying any type of debt, you may be looking at opportunities to lower your rates.
With mortgage interest rates at historic lows, you may even be wondering if you should tap your home’s equity to pay off higher-interest debt, including your student loans. This might be a good option if you qualify for a student loan cash-out refinance, which uses home equity to pay off student loans. Here’s what to know before you apply.
How a student loan cash-out refinance works
If your home value is higher than your mortgage, you have home equity, and you may qualify to borrow against that value and use the money for different purposes. A student loan cash-out refinance involves applying for a bigger mortgage to cover your mortgage balance alongside one of your student loans.
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To qualify for a Fannie Mae-backed student loan cash-out refinance, you need to hold at least 20% equity in your home to qualify—and you must pay off at least one student loan in full in the process. (You can see Fannie Mae’s full eligibility requirements—including acceptable credit scores and debt-to-income ratios—here.)
Many lenders don’t advertise student loan cash-out refinances—although SoFi is one of the better-known exceptions. You may also shop around online through popular mortgage comparison websites.
The risks of a student loan cash-out refinance
The biggest risk of a student loan cash-out refinance is adding to your mortgage balance. While you may lock in a lower interest rate, you may also increase your monthly mortgage payment. This may be particularly risky amid the pandemic and a shaky economy. You may also be reducing your home equity, which could limit your borrowing options in the future.
You should also consider refinance closing costs, and how long it will take you to break even on the transaction. If you don’t have a large student loan balance, spending thousands on closing costs may not be worth it.
If you’re among the most creditworthy borrowers (high credit score, low debt-to-income ratio and steady employment) you may explore less risky options—like refinancing your student loans themselves. One benefit of this option: you won’t lose your tax deduction for student loan interest.
There are some big risks involved in refinancing from federal to private student loans, though.
The risks of refinancing your federal student loans
If you’re thinking about refinancing federal student loans, there are some additional risks to consider. You may be giving up valuable borrower protections—like the latest pause on federal payments through 2020—or future opportunities for deferment or forbearance.
Another major downside is losing access to Public Service Loan Forgiveness or more flexible, income-driven repayment plans. With so much at stake, you should consider whether locking in a lower interest rate is worth it—particularly during a time of economic uncertainty.
