It’s no secret: American graduates are often overwhelmed by student loans. With the average student loan debt climbing every year, more grads are struggling to make ends meet while paying them off.
One new option may provide the solution for some borrowers. A program offered by lender SoFi and backed by Fannie Mae allows grads to essentially turn student loans into mortgages at a much lower interest rate. While this program, known as the Student Loan Payoff ReFi, has significant advantages, there are drawbacks as well.
How It Works
To participate in the Student Loan Payoff ReFi, you must own a home. This means most new graduates will not likely be able to participate, but their parents or older grads who own homes may be able to apply. You simply refinance a mortgage through SoFi, and take out additional home equity in the form of cash. SoFi then uses that money to pay off your student loans. The cash is never in your hands; instead, it goes directly to the student loan servicer. You have a larger mortgage (original mortgage plus amount of cash to pay off student loans) with a lower interest rate.
For many college graduates — particularly those with private loans or graduate school debt — this program makes a lot of financial sense. Current rates for mortgages are around 3.5 percent, while rates for federal undergraduate student loans are 3.76 percent and those for private loans can be 6.5 percent or higher. By transforming student loan debt into a mortgage, borrowers are often able to significantly cut their interest rate and the total amount that they will have to pay on their loans.
In the past, homeowners could pay off their student loans using a home equity loan or line of credit. However, a second mortgage or line of credit typically has a much higher interest rate than a mortgage. This means it rarely made sense to use this option, as the home equity loan would often be as much or more than student loan interest rates.
That is why the SoFi program is so attractive: current mortgage rates are low, and your student loan is combined with your mortgage into a single debt. SoFi waives origination and other lender fees, making it far less expensive than other loan alternatives. It optimizes the historically low mortgage interest rates to help students pay off their loans much more quickly and at a lower cost.
Up to 8.5 million households are potentially able to take advantage of this program to either pay off or pay down their student loan debt. This includes parents and others who have co-signed loans as well as homeowners with their own student loan debt. To be eligible for the program, borrowers typically must have a credit score of 620 or higher (in accordance with Fannie Mae guidelines). They also must have enough equity in their home to use the program; the standard is that the loan to value ratio must not exceed 80 percent. This means that if a home is valued at $200,000, the new loan cannot be for more than $160,000. If a homeowner still owes a significant amount on his or her mortgage, it will not likely make sense to enter this program, as the borrowed amount may not be enough to pay off or pay down the student loans. The Student Loan Payoff ReFi is currently only available where SoFi is licensed to issue mortgages, in 27 states and the District of Columbia.
Risks of Using a Mortgage to Pay Off Student Loan Debt
While the advantages of the Student Loan Payoff ReFi are readily apparent, there are drawbacks that may not be as obvious. This includes increasing the life of your loan and the very real possibility of losing your home if you default on your mortgage.
There is a reason why mortgages are typically offered at a lower rate: because they are secured with collateral in the form of the home itself. Student loans are unsecured debt, which means that you do not put up collateral to get them. If you do not pay your student loan there are consequences, but they largely relate to your credit score. However, if you default on a mortgage, the bank may foreclose on your home — a much bigger risk.
Student loans also have certain protections that mortgages do not have, such as flexible repayment options, deferment, and even loan forgiveness programs. Mortgages have none of these protections; if you participate in the Student Loan Payoff ReFi program and you lose your job or become disabled, you will have no recourse. If you can’t make your mortgage payments, you may ultimately lose your house.
Beyond the possibility of defaulting on a mortgage, there is the possibility that even with a lower interest rate, you’ll pay more over time with a mortgage than with a student loan. That is because most mortgages are for 30 years while most student loans are for 10 years. You will pay a lower interest rate, but for a longer period of time — potentially negating any benefit of doing this program. One way to get around this is to get as short of a mortgage term as possible (usually 15 years) and to pay additional money each month towards your loan in order to pay it off more quickly.
Despite these drawbacks, many student loan borrowers can still benefit from the payoff program. This is particularly true for anyone with private loans, which tend to have higher interest rates and lower protections than loans backed by the federal government. So if you are eligible for the student loan repayment program, do the math and carefully consider whether you would benefit from refinancing your loans through SoFi’s Student Loan Payoff ReFi.
Author: Jeff Gitlen
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