4 Risks to Refinancing Your Mortgage to Pay Off Student Loans

In 2019, Americans collectively owed 1.6 trillion in student loan debt – a number that has been steadily increasing for the past few decades. With so many young Americans weighed down by the burden of student loans, many are finding it difficult to pay down their loan balances while also achieving goals like marriage, homeownership and starting a family.

In some cases, homeowners may be able to refinance their mortgage to pay off student loans. While this program may sound promising, you should approach it with caution. Taking advantage of this approach essentially involves putting your house on the line. If you’re unable to make payments in time, you may risk foreclosure. This approach also means that it will take longer to pay off your mortgage and you may lose out on other debt relief and forgiveness options.

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In this article

    What is mortgage refinancing?

    Mortgage refinancing allows homeowners to replace their current mortgage with a new one. In many cases, refinancing can help you to secure better rates and lower your monthly mortgage payment. If you’ve already built up equity in your house, you can opt for a cash-out refinance. This allows you to borrow more than you owe on your current loan and use the extra money for other purposes. However, the decision of whether or not to refinance your mortgage should not be taken lightly. While there are some benefits to a cash-out mortgage refinance, it’s important to be aware of the risks and make the financial decision that is best for your situation.

    How the student loan cash-out refinance works

    If you’ve built up equity in your house, you can use a student loan cash-out refinance to pay off your student loans. Interest rates for refinanced mortgages are often lower than interest rates on student loans, so this can help to reduce your monthly payments and save you money in the long run. Although most cash-out refinances come with associated fees, these fees are waived if you use the money to pay off student loans.

    To refinance your mortgage and cash out your student loans, you should first have sufficient equity in your home. This means that you’ve paid off enough of the value of your home that you can leverage these payments to refinance your mortgage. A cash-out student loan refinance works the same as a regular mortgage refinance, except that you must use the money exclusively to pay off student loans. In order to qualify, you must pay the money from the refinance directly to the student loan servicer.

    4 risks to refinancing your mortgage to pay off student loans

    While using a student loan cash-out refinance to pay off your student loans may sound like a good deal, there are a variety of risks associated with it. Since a cash-out refinance uses your home as collateral, you’re at additional risk of losing your home if you find yourself unable to make monthly payments. In addition, if you opt for a cash-out refinance you’ll sacrifice many of the protections associated with federal student loans.

    1. Your home is used as collateral

    When you refinance your house to pay off your student loans, you’re essentially using your house as collateral. This means that if you’re unable to make payments you may run the risk of a foreclosure on your house. Student loan debt isn’t tied to any particular collateral – they can’t take away your education or degree even if you fall behind on payments. Putting all your eggs in one basket when it comes to debt payments may sound appealing for simplicity’s sake, but it also comes with much greater risks.

    2. You lose important protections

    When it comes to federal student loans, there are important protections in place that can help out borrowers during tough financial jobs. If you have a hefty student loan burden and are struggling to make your monthly payments, you may be eligible for income-based repayment options or even temporary loan deferment. Mortgages don’t come with any of these protections, so if you use a student loan cash-out refinance, you’re no longer eligible for them.

    3. You’re putting your home at risk and eliminating equity

    To be eligible for a student loan cash-out refinance, you need to have built up equity in your home. When you roll a student loan into your mortgage, you significantly increase the amount you owe on your house and eliminate the equity you’ve built up so far. This can make it more difficult to sell your house for the cost of your mortgage in the future. It also means that it will take more time and money to pay down the mortgage on your home.

    4. You miss out on tax deduction opportunities

    When tax season rolls around, taxpayers with student debt are allowed to deduct student loan interest from their income taxes. If you roll your student loans into your mortgage, you are no longer eligible for this deduction. This means that you may have to pay more in taxes than you otherwise would.

    Benefits of refinancing your mortgage to pay off student loans

    Although there are a lot of risks associated with opting for a student loan cash-out refinance, there are also some benefits. A cash-out refinance can simplify your monthly payments, making it easier to pay off your loans. It may also help you to secure better interest rates that can save you money over time.

    1. Simplifying your loan payments

    When you refinance your mortgage to pay off your student loans, you’re essentially lumping your student loans in with your mortgage. This means that you’ll only have to make one lump sum payment each month, and only have one large loan to worry about. If you’re overwhelmed by the number of loans and bills you have to pay each month, a student loan cash-out refinance can help to simplify the process

    2. You may qualify for lower interest rates

    In general, mortgages have slightly lower interest rates than student loans. If you opt to refinance your home to pay off student loans, you’ll probably end up paying slightly less in interest than if you’d left your student loans accounts alone. This means that you’ll end up paying less money over time and may be able to pay off the balance represented by your student loans that much faster.

    Alternatives to refinancing your mortgage to pay off loans

    If you’re considering refinancing your mortgage to pay off your student loans, you may also be eligible for a variety of alternatives. These may include traditional student loan refinancing or a home equity line of credit. These options offer many of the same benefits as a cash-out refinance depending on your particular situation.

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    1. Traditional student loan refinancing

    Traditional student loan refinancing is similar to a student loan cash-out mortgage refinancing in that it allows borrowers to consolidate their student loans and often secure a lower interest rate. This practice is also sometimes known as loan consolidation. While this can, in some cases, significantly lower the amount of interest you’ll accumulate on your student loans, it also strips you of many federal student loan protections, like income-based repayment and temporary loan deferment.

    2. Home Equity Line of Credit (HELOC)

    Borrowers with equity invested in their homes also have the option of taking out a home equity line of credit, otherwise known as a HELOC. This line of credit generally has higher interest rates than a mortgage refinance and comes with many of the same risks. However, it can be a good option for borrowers who are looking to pay off their student loans and don’t mind the additional risk it places on their house.

    Margaret Wack

    Contributing Writer

    Margaret Wack writes about personal finance, health, wellness, arts and culture, among other topics.

    Reviewed by

    • Angelica Leicht
      Angelica Leicht
      Editor

      Angelica Leicht is a writer and editor who specializes in everything mortgage-related for The Simple Dollar. Her work has spanned topics that include lending product reviews, interest rate trends, racial biases in mortgage lending and the role of fintech in lending practices, and has appeared in publications such as Interest, Bankrate, The Spruce, Houston Press and VeryWell, among others.