Going back to school or helping a child pay for their education can be daunting, especially as tuition fees continue to rise. Most families are unable to cover the full cost of college with grants and scholarships alone, and many will explore student loans to cover unmet needs.
Homeowners, however, may have another option: refinance their mortgage to increase their available savings.
Saving even a little for college can have a big impact when it comes to paying tuition. The more you save, the less you will have to borrow. Remember that student loans must be paid back with interest, which can really add up over time.
The easiest way to save money is to cut spending on the biggest recurring costs in your budget, like a home loan. According to United States Census Bureau data as of July 2021, the average homeowner spends more than $1,600 per month on mortgages and other housing costs.
If you’re a homeowner, you could save hundreds of dollars a month by refinancing your home loan. It could also free up more funds to spend on tuition.
But refinancing a mortgage may not be the right path for everyone. It depends on a variety of factors, such as credit scores, interest rates, and specific college costs.
If you think refinancing your mortgage to pay for your education might be the right decision, here are some things to consider.
Will you generate enough savings over time?
People with a higher level credit scores get better interest rate deals on their mortgages, saving them hundreds of dollars a month. For example, a family paying $200 less per month on their mortgage would save $12,000 in five years.
That’s more than enough money to cover the average tuition for two years at a community college, according to reported data by the National Center for Education Statistics.
Knowing when tuition is due is another key consideration. It takes years to generate savings from a refinanced mortgage. Some people may not have the luxury of waiting five years, for example, because they go straight to college.
If your goal of refinancing is to save for tuition, make sure you have plenty of time to save the amount you’ll need before you start or your student starts school.
Variable or fixed interest rate loans
Not all lenders charge a fixed interest rate for the term of a home loan. Some lenders use an adjustable rate loan, also called a variable rate loan. This means that the mortgage interest rate may vary over time depending on market conditions.
Some lenders may offer families an adjustable rate refinance loan, but consumers should be aware that the interest on such an adjustable rate loan may increase over time. The initial rate may be lower, but this may not remain the case. Homeowners could end up paying much more than expected if market interest rates spike.
The Federal Reserve recently reported that it will raise interest rates to help curb inflation. Families considering refinancing their mortgage to help pay for college would be wise to consult a financial advisor before doing so and before agreeing to an interest rate that may change later and be more costly over time.
Extension of mortgage repayment period
Extending the term of the mortgage can reduce monthly payments and, in theory, families can then spend those savings on college. However, this strategy also has drawbacks.
For example, this may mean that a family pays more interest on the long-term mortgage, which could end up being less affordable than a student loan depending on interest rates. Check how much additional interest would accrue before using this strategy.
Alternatives to Mortgage Refinancing
Again, not everyone has a home loan or the ability to refinance one. For these families, taking out a student loan may be their best or only choice.
And it’s not a terrible option. Interest rates on subsidized and unsubsidized direct federal student loans are currently 3.73% for undergraduate students. Many home loans have higher interest rates, especially for families with average or below average credit.
The federal government tends to offer more favorable student loan terms than banks and other private lenders. State-based, non-profit student loan agencies are another good option for families, as they tend to offer student loans with transparent and generous benefits.
Ultimately, every college funding strategy has tradeoffs. Refinancing a mortgage could be a decent alternative to taking out a student loan, and families should take the time to choose the best option for their unique needs.