Paying for school can be challenging, especially as the costs of college rise.
There are options, though. And if you’re a homeowner (or your parents are), you may have more options than others.
A home equity line of credit (or HELOC) is one such option. In this guide, we’ll explain how HELOCs work, how to use one for college costs, and how this financing option compares to traditional student loans.
How to decide if you should use a HELOC for college:
- Understand how a HELOC works
- Are you eligible for a HELOC?
- How does your HELOC offer compare to student loans?
- Decide whether you should use a HELOC to pay for college
- If you decide to use a HELOC, compare offers and apply
- Receive the funds and pay for school expenses
- Create a plan for repayment
1) Understand how a HELOC works
A HELOC lets you borrow money against your house. As a line of credit, it works much like a credit card and can have either a variable or fixed interest rate, depending on your lender.
The size of your HELOC depends on your home’s value. Most lenders will lend up to 85% of your home’s value—minus any balance you have on your primary mortgage. If your home is worth $500,000 and your mortgage balance is $200,000, you could take out $225,000 via a HELOC ($500,000 x 0.85 – 200,000).
Typically, HELOCs have 10-year draw periods, meaning you can withdraw money as needed for the next decade up to the maximum amount available. During this period, you’ll usually only pay interest on what you’ve withdrawn.
If you were using the funds for college costs, you would withdraw only as much as you need for that upcoming semester. Then, you’d start making interest-only payments on those funds.
Once a HELOC’s draw period is up, you’ll begin making regular principal and interest payments back to your lender. Since a HELOC uses your home as collateral, failure to make payment could lead to your home being foreclosed.
2) Are you eligible for a HELOC?
To qualify for a HELOC, you’ll need a good amount of equity in your home. You’ll also need to be in good standing on your existing mortgage—meaning you’re up to date on payments.
Eligibility requirements vary by lender, but here’s an example of what you need to qualify for a HELOC with our partner, Figure:
- Minimum credit score: 640
- Loan-to-value ratio: 75% to 95% (the higher your credit score, the more you can access)
- Income: Must be employed, self-employed, or retired
- Property: Single-family residences, townhomes, planned urban developments, or condos
You can apply for a HELOC with your mortgage lender, but shopping around ensures you get the best pricing and terms. Most lenders prequalify you for a HELOC without a hard credit check. Prequalifying allows you to check your eligibility and HELOC costs without hurting your credit.
What if the lender doesn’t let me prequalify?
Most lenders let you prequalify for a HELOC, but if they don’t, proceed carefully. Filling out a complete application might result in a hard credit check, which could hurt your credit score—and make it harder to get a loan.
Before applying in full, make sure you’re set on the HELOC and the lender you’re applying with. If you’re unsure, you can also use an online rate-shopping tool to help compare your options. Reading lender reviews can also help point you toward the best choice.
3) How does your HELOC offer compare to student loans?
If you’ve been prequalified with one or multiple HELOC lenders, you should have cost details that can be used to compare this financing option to student loans to see which is more affordable.
With student loans, you have two options. You can choose:
- Federal student loans: These include loans for students and parents of students. You can apply for these using the Free Application for Federal Student Aid.
- Private student loans: These loans are offered by private companies and typically come with higher interest rates than federal loans.
If you’re a parent or legal guardian, you’ll want to compare your HELOC estimates to a Parent PLUS loan. In the table below, we’ve compared the terms of a Figure HELOC to those of a Parent PLUS loan. For a more direct comparison, replace the Figure estimates with your prequalified terms.
|HELOC (Figure)||Parent PLUS|
|Borrowed amount||$15,000 to $400,000||Up to the total cost of attendance, minus any other financial aid|
|Rates (APR)||3.99% to 11.16%||7.54%|
|Repayment terms||5, 10, 15, or 30 years||Up to 25 years|
|Origination fee||Up to 4.99% of the initial draw||4.228%|
You can create similar comparisons for other loans you might be considering. Make sure you use a calculator to determine the potential long-term interest costs, and factor in the upfront costs of borrowing. These include things like origination fees, account fees, and more.
Consider repayment benefits offered by student loans
Federal student loans typically have more repayment options than private student loans and HELOCs. There are income-driven repayment plans, which base your payments on your monthly income, and hardship options, like deferment and forbearance. These allow you to pause payments temporarily if you’re struggling.
In some cases, federal loans are forgivable (meaning you don’t need to repay the remaining balance). This may be true for borrowers who enter a public service field, like teaching or law enforcement.
You should also consider the different risks of HELOCs and student loans. Not paying your loans could hurt your credit score or lead to wage garnishment (where the government takes money out of your paychecks to repay your debt).
However, HELOCs put your home at risk. If you fail to make payments, your lender could foreclose on the property and remove you from your home.
4) Decide whether you should use HELOC to pay for college
It’s usually best to exhaust all federal aid before moving to a HELOC or other financing product. If you’re considering private student loans (or private parent loans), a HELOC may have better terms which is why it’s so important to compare the two.
Since HELOCs are secured by collateral, they often have lower rates than private loans. They allow you to withdraw (and pay interest on) only what you need, rather than borrowing a large lump sum as private loans require.
You might not want a HELOC if finances are tight or your income is unstable. This could make it hard to make your payments and put you at risk of foreclosure. Also, if you have a low credit score, you’ll likely receive a high interest rate and face significant costs in the long run, though that could be the same for a private student loan.
5) If you decide to use a HELOC, compare offers and apply
If you decide that a HELOC is right for you, you can submit a full application from the prequalified offer you received earlier or apply with a new lender. Make sure to have your estimated semester costs in hand, including housing, supplies, books, and food, so you ensure your line of credit will cover all necessary costs. Consider adding a buffer into the total credit line.
When completing your application, you’ll typically need to provide tax returns, a mortgage statement, a property tax bill, a copy of your home insurance policy, your Social Security number, and other financial details. The lender will also run a hard credit check at this point, which will impact your credit.
6) Receive the funds and pay for school expenses
After you’re approved for your HELOC, you’ll need to draw the necessary funds from your account and pay the school directly—usually through their business, finance office, or the school bursar.
You’ll need to do this every semester, so be sure to check with your school for upcoming tuition deadlines.
7) Create a plan for repayment
Since HELOCs use your home as collateral, you must have a plan for repayment from the start. Set up auto-payments if possible, or, at the very least, configure calendar alerts leading up to each payment due date.
You should also create a household budget and start saving to make larger payments once your draw period ends. Remember: After 10 years, you’ll need to start repaying the principal and interest on your credit line. Missing payments could put your home at risk of foreclosure.
Pros and cons of using a HELOC to pay for college
Still not sure if a HELOC is right for you? Consider these pros and cons.
May have a lower interest rate than Parent PLUS or private student loans
Only take out the funds you need
Interest-only payments during the draw period
You may receive a variable interest rate that could increase over time
Your house is used as collateral and could be foreclosed if you miss payments
If you understand the risks and are prepared for the payments, a HELOC could help you cover educational costs now and in the future after you’ve exhausted your federal aid options. Make sure you shop around for your HELOC and compare several lenders to get the lowest rate.
>> Read More: What else can a HELOC be used for?