Why You Should or Shouldn’t Use Home Equity to Pay for College
College is incredibly expensive. Tuition costs have risen over 511 percent over the past two decades. There isn’t a single consumer good or service that has risen that high within the same time period. Students need to get financing from every source they can, and of course parents want to help. Some parents may be tempted to use their home equity to help their children through school, but while that’s a perfect solution for some, it only causes problems for others. Home equity should only be used when it’s part of a strategy that makes sense, and there are a few things parents and students should know before deciding on a plan.
Pro: Tax Benefits
Parents who bought a house so they could raise a family will suddenly find themselves with a lot of empty space once the kids are off to school. At that point it no longer makes sense to keep such a large house or to pay the extra cost for utilities, maintenance and repairs. Since downsizing is a desirable option anyway, they can take advantage of the tax breaks that are available after having owned a house for two or three decades.
Parents who sell their homes gain access to savings that are exempt from income taxes, and since the money is going toward education, there are education tax credits and exemptions that further sweeten the deal. It’s not necessary to sell the family home, either; if downsizing is not the preferred option, all of that home equity can be accessed through a second mortgage, and taking on a new mortgage can allow someone to accrue even more equity over time.
Con: Selling and Refinancing Can be Risky
Not everyone has perfect credit, and if someone has run into problems in the past, taking equity out of his home can be an expensive proposition. Under most circumstances, people who have been in their home long enough to see their kids graduate can get new home loans at reduced rates, or they can refinance without seeing an increase in their monthly payments or interest rates.
Even in the best of circumstances there is some risk involved, especially in the wake of the housing bubble. Some homes have actually declined in value, and it’s not a good idea to sell or take out a new loan if it means getting less money than what’s been paid into the mortgage.
Pro: Prepaying Has Huge Advantages
Since college is an almost guaranteed expense for most families, a plan should be formed around the time that the first child emerges from the womb. The money that would go into a college fund should be put toward the principal on the mortgage, and families who can afford it should try to get a 15 year mortgage as opposed to the usual 30 year loan.
This strategy yields two major benefits: Parents end up paying far less in interest, and their home is paid off by the time their first child is in high school. On top of that, 15 year mortgages tend to have better interest rates, so the savings are pretty substantial. The net value of their home is also ignored by the federal need analysis formula, and that can be a huge help to their kids. A college strategy that focuses on home equity can do more than just pay for someone’s education, it can be hugely beneficial to a family’s overall financial profile.
Con: Investing a Lot of Money Into a Home Limits Other Investments
While pouring every spare penny into a home might sound good on paper, it doesn’t work so well for some people in practice. It essentially boils down to making a big bet on real estate, and while real estate is a fairly stable market, it goes through ups and downs just like everything else. It’s a sound strategical decision for people who would spend all of their money anyway, or people who live in an affluent area where housing values are certain to keep rising, but it’s not a good idea for anyone who wants to diversify.
It Comes Down to Individual Circumstances
Using home equity to finance a college education is not strictly a good or bad decision. It all comes down to what people want to accomplish over the long-term, and it also hinges on when they get serious about planning their finances. A couple who is just getting things figured out five years before their oldest child graduates should probably avoid using a strategy that hinges on home equity. Parents who are planning their family’s future before kids are even in the picture will be okay no matter what they decide to do.
The one thing that pushes home equity over the edge as a college financial strategy is that it’s one of the few ways that consumers can pay for school without taking on massive debt through college loans. College loans are not at all forgiving, and they can place students under a crippling amount of debt for decades following graduation. If the risks associated with using home equity aren’t enough to dissuade parents from doing so, it may just be the surest way to make sure their children enter the world with both an education and a future.
Nicole Pollock is a guest writer for www.netloans.co.uk where you can find out more about net loans.