New Program Pays Off Student Loan Debt By Refinancing Mortgage
A new program is giving students — and their parents — a chance to take advantage of low mortgage rates by refinancing a mortgage and swapping student loans for a lower mortgage rate.
Interest rates on student loans are 2-3 percentage points higher than fixed-mortgage rates, making owning a home cheaper — as far as interest rates go.
The Student Loan Payoff ReFi program from lender SoFi and backed by the government-controlled mortgage association Fannie Mae helps young people get rid of a problem that often prevents them from buying a home: having too much student debt.
“People who have student debt postpone the decision to buy,” says Jonathan Lawless, vice president of product development and affordable housing at Fannie Mae in Washington, D.C.
The program also taps into $8 trillion tied up in home equity across the country, compared to $1.4 trillion in college loans, Lawless says.
How the student loan payoff program works
Program participants can either be homeowners with student loans, parents with homes who co-signed student loans for their children, or parents with homes and their own parent loans. The program allows them to refinance their mortgage and take out additional home equity as cash, which is paid directly to the student loan.
They end up with a lower interest rate and more of their student loans paid back, but with a larger mortgage, less equity and lose some protections that federal student loans offer.
Homeowners can already use other loans such as home equity loans or a line of credit to get extra money out of their home and pay off student debt. But those second mortgages usually have a higher interest rate than the first loan.
The new program would waive that additional cost, up to 0.25 percent, Lawless says, and combines the refi and original home loan into a single loan.
Do the math first
He gives the example of a $160,000 loan at 3.5 percent interest on a 30-year fixed-rate mortgage, with a monthly payment of $718. If the interest rate increased to 3.75 percent, the monthly payment increases to $741, or $8,280 more over 30 years.
The current interest rates of your home and student loans are the main factors in deciding if the SoFi refi program is worthwhile.
Interest rates on student loans range from 3.76 percent to 6.31 percent, though they’re likely much higher for homeowners with student loans from years ago. Private student loans that usually require a co-signer usually have much higher rates than federal loans.
The average student loan has a 6.5 percent interest rate, while the average fixed-rate mortgage for 30 years is 3.75 percent, says Michael Tannenbaum, senior vice president of mortgage at SoFi. A cash-out refi can add half a percentage point or more to a home loan, Tannenbaum says.
Borrowers must have a loan-to-value ratio, or LTV of 80 percent or lower. The difference between their LTV and the 80 percent LTV allowed is the amount that can be used to pay off student loans.
For example, a $120,000 loan balance on a home valued at $200,000 is a 60 percent LTV. The borrower could increase their LTV to 80 percent by adding $40,000 to their principal for a $160,000 mortgage, giving them $40,000 to pay student loans.
SoFi estimates that 8.5 million homeowners could benefit from the program. The average homeowner who has co-signed a student loan has a student loan balance of $36,000, and parents with their own student loans have $33,000 in student debt.
Student debt protections lost
A drawback of the program is that by moving student loan debt from a federal student loan program to a mortgage refi is that some federal protections on student debt are lost.
A home loan uses the home as collateral if the loan isn’t paid. Defaulting on a student loan can ruin a credit score, but it usually doesn’t have a home as collateral.
Federal student loans allow payments to be deferred for a job loss, or payments can be lowered if your income drops. Student loans can also be deferred for a year for borrowers who work abroad for a volunteer organization.
Lastly, student loans usually last 10 to 20 years, Lawless says, while adding it to a 30-year mortgage extends it — though at a lower rate.