By Dr. James M. Dahle, WCI Founder
Nobody was asking this question back in 2010, but after a decade of rising housing prices, those with heavy student loan burdens who happen to own a house are starting to look at that home equity and wonder if there is a better use for it. What factors should be considered when deciding whether to sell your home in order to get out from under your student loans?
Where Will You Live If You Sell Your House?
I generally recommend you separate the various parts of your financial life, combining them only when necessary. When you take our flagship course, Fire Your Financial Advisor, you will write a financial plan that includes an insurance plan, an investing plan, a housing plan, and a student loan plan among others. Each of these plans is free-standing—independent from the others. When you start thinking about selling your home to pay off your loans, you are combining these plans in ways that often don't work out well.
So the first question that should come up when you consider this is “Where will you live?” You still need a housing plan. If you sell your house to pay off your student loans, you will either need to buy a new house, or start renting. It's not like either of those options is free. They both cost money, and that money will need to come from somewhere. If the right housing plan for you was to buy a house, why would you now want to rent? If the right house for you was the one you bought, why are you now selling it?
Now if you are going to sell the house anyway to move to a new town and your new housing plan is to rent or buy a much cheaper house, then perhaps it would make sense to take that home equity and pay off your loans with it. But if your housing plan hasn't changed, I see little reason to use the money in the housing plan for the student loan plan.
Perhaps your housing plan has not changed. You still plan to live in the same place. You just want to use some home equity via a cash-out refinance or a HELOC to pay off student loans. Maybe you can get a 3% mortgage with deductible interest whereas you had 6% student loans whose interest was not deductible to you. This can make a little more sense, but you are still moving money from your housing plan to your student loan plan.
Transaction Costs of Selling Your House
Buying a home, selling a home, and moving are all very expensive. Maybe not as expensive as divorce, but there's a reason the two are combined in the old adage, “One house, one spouse.” Typically, round-trip costs for buying and selling a home are 15% of the value of your home. You're going to need to save A LOT of interest to make up for that. Let's do the math on this. Let's say you bought a $500K house with a $100K down payment. Over the last few years the house has appreciated to $650,000 and you've paid down the mortgage a bit. Let's say there is now $300K in home equity there and you're looking at your $300K in student loans and wondering if a swap is wise. Well, let's say you sell the house. You plan to buy a new one eventually, so let's use the full 15% * $650,000 = $97,500 as your transaction cost. A $300,000, 6% student loan generates $18,000 a year in interest. It will take more than 5 years for the saved interest to be worth the transaction cost. That can't be a smart move.
Transaction costs on a refinance or a Home Equity Line Of Credit (HELOC) are not quite as high. Most importantly, you save on moving costs. But those costs are not zero. If you go from a $300,000, 6% student loan to a 3% mortgage, you're only saving $9,000 per year in interest. 3% in closing costs could eat up two years of interest savings.
Opportunity Cost and Risk
Homes generally appreciate, increasing in value over time. So while you're out of the home or in a less expensive home for a few years, you are likely to miss out on some appreciation you would otherwise get. How dumb would you feel to sell your home to pay off student loans only to see the home appreciate dramatically over the next couple of years?
You can reduce this risk by refinancing or using a HELOC instead of selling, since you will still own the same home. Naturally, there is always a risk that the home will fall in value. If you have a functioning crystal ball, you might be able to time it just right to sell at the peak of a housing bubble, pay off your student loans with the proceeds, and then buy back in at the bottom after a bust. My crystal ball always seems to be too cloudy to successfully pull those sorts of stunts off, though, not to mention the disruption to my housing plan.
Another risk of swapping student loans for home equity is that your house can be foreclosed on. Nobody is going to take your education away from you. So trading an unsecured debt for a secured one may not be a good idea. On the other hand, in a non-recourse state, you can at least get rid of mortgage debt in bankruptcy. Student loans don't go away in bankruptcy.
Home Equity vs Debt Size?
This also doesn't work well if there is a severe mismatch between the home equity and the student loans. If you only have $30,000 in available home equity and $300,000 in student loans, it's not going to move the needle much. Likewise, if you have $300,000 in home equity and $30,000 in student loans, there's no way the interest savings will ever recoup the transaction costs.
Comparing Interest Rates
You also need to look at the interest rate difference of a mortgage and student loans. If they're both 4%, you're not going to save much by moving debt from one place to another with a HELOC or refinance. Be sure to use after-tax interest rates.
The Bottom Line: Don't Sell Your House to Pay Off Student Loan Debt
Unless you are moving anyway, it almost never makes sense to sell your home in order to pay off your student loans. Even anti-debt fanatics like Dave Ramsey recommend against that. You need a real student loan plan. Most of the time, that means you will be doing one of two things:
- Qualifying for a federal forgiveness program such as Public Service Loan Forgiveness or
- Refinancing your student loans and living like a resident for a few years so you can pay them off quickly
If you need help deciding between these two plans, we recommend an easy 1-hour consultation with StudentLoanAdvice.com.
If you are considering getting a HELOC or refinancing to swap student loan debt for mortgage debt, be sure to consider the risks, weigh the transaction costs, and compare interest rates. You can probably get just as good of a rate by simply refinancing your student loans, and there is no risk or transaction cost to doing that.
What do you think? Have you sold a house to pay off student loans? How did it work out? How about a HELOC or refinance? Comment below!