If you’re a homeowner, you may have wondered “Should I refinance my home to pay off student loans?” A student loan cash-out refinance program lets you accomplish this goal by leveraging your home’s equity to refinance your student loan and home loan together.
There are benefits to this debt repayment strategy, as well as caveats. Keep reading to learn about how to refinance your home mortgage to pay off student loans, and the pros and cons.
How a student loan cash-out refinance works
Using a refinance home mortgage to pay off student loans is a type of debt consolidation strategy. Through a student loan cash-out refinance, homeowners use their home’s equity to get approved for a larger mortgage loan. Funds from the new loan pay off the existing mortgage, and the remaining funds can be used to pay off student loan balances.
After the student loans and original mortgage are paid, borrowers are responsible for repaying one new cash-out refinance mortgage loan.
Where to find a student loan cash-out refinance
If you’re interested in a student loan cash-out refinance, there are limited lenders that offer this option. Be sure to check the eligibility requirements to find the best fit for you.
Fannie Mae launched its student loan cash-out refinance program. Typically, the maximum loan-to-value (LTV) you can take out is 80% on your principal residence. This LTV lets you take out a new mortgage in the amount of 80% of your home’s equity. Home equity is how much your home is worth compared to what you still owe on your mortgage.
According to Fannie Mae’s Selling Guide on student loan cash-out refinance, under this program, you must:
- Pay your student loans in full.
- Direct cash-out refinancing proceeds to your student loan servicer at closing.
- Have one borrower that has a loan balance on the mortgage.
You can also pay off your existing first mortgage. This results in a single, larger mortgage that consolidates other loans. Additionally, you can qualify for up to $2,000 cash back or 2% of the refinance loan, whichever is less.
Fannie Mae launched this program but partners with lenders to execute it. One of the primary lenders is SoFi. You can also reach out to local mortgage lenders to see if they participate in this program.
Through this option, you can refinance your mortgage and pay off your student loans, while taking advantage of low mortgage interest rates. Its standard mortgage refinance product allows for a maximum LTV of 80%, but SoFi doesn’t disclose information about its student loan cash-out refinance option.
A general cash-out refinance can be used to get cash for home renovations or debt and more whereas a student loan cash-out refinance is exclusively used to pay off current student loan debt. You may be able to get a repayment term of 10 to 30 years with no prepayment penalties.
Pros and cons of a student loan cash-out refinance
A student loan cash-out refinance can be an attractive option, depending on your situation. Here are a few benefits of student loan cash-out refinance loans.
Pros of a student loan cash-out refinance
- You’ll streamline your debt repayment. By using a student loan cash-out refinance, you pay off multiple loans, and only one (albeit larger) loan account to pay back.
- You might have a lower interest rate. If you have high-interest student loan debt such as Grad or Parent PLUS Loans and have strong credit, you might be able to get a lower mortgage rate. Lower interest rates save you money over time.
- You’ll leave your student loan servicer. If you dislike your student loan servicer, paying off your loans with a student loan cash-out refinance is one way to ditch them. But remember, you still have another loan and lender to deal with, which may or may offer a better experience.
Cons of a student loan cash-out refinance
Although a cash-out refinance strategy can help streamline your debt and offer savings in some ways, there are also major drawbacks.
- You won’t get a tax benefit. After refinancing your student loans, you’ll lose access to student loan interest deduction.
- You’ll lose federal student loan protections. Refinancing federal student loans, specifically, will cause you to forfeit valuable benefits like loan forgiveness, income-driven repayment, and extended deferment and forbearance.
- You might pay more money over a longer mortgage term. If your cash-out refinance term is longer than your remaining student loan timeline, extending your student debt over a new 30-year period can cost you more in interest charges.
- You’re putting your home at risk. Education debt is considered unsecured debt. If you don’t pay it back, your credit score will drop and you risk having your wages and tax refund garnished. But if you fail to repay your cash-out refinance — a collateral-based mortgage loan — you can lose your home to foreclosure.
When a student loan cash-out refinance might make sense
It’s important to fully understand the math and have a strategy to pay back the debt. Below are a few reasons this strategy might be an option:
- If you want to streamline your debt. By combining your mortgage and student loan payments into one loan, you’ll have fewer loan accounts and payment due dates to stay on top of.
- If you want to ditch your student loan servicer. Once federal loans leave the national student loan system, it becomes private debt and won’t have to work with your original servicer.
- If you want to lower your debt-to-income ratio. If you pay off your student loans and have a single mortgage loan with a longer repayment term, you could end up with smaller payments (and paying more interest) and a lower debt-to-income ratio. You may be able to improve your credit score with a lower debt-to-income ratio and have higher chances of approval for other types of credit.
- If you want lower monthly payments. Getting a new loan with a new repayment term over a longer period can lower your monthly payments. You’ll pay more in interest but your monthly payments will be smaller.
It’s important to understand that while your payments might be lower due to a longer repayment term. You’ll also pay more in interest due to the higher loan amount, and might face potential fees and expenses with a new loan.
Alternatives to student loan cash-out refinance
A student loan cash-out refinance makes you ineligible for student loan forgiveness or income-driven repayment, making this repayment approach unwise if you’re already struggling to make debt payments.
Paying off student loans with this approach is a considerable risk, if you can’t repay the cash-out refinance loan. However, there are alternative options, if your goal is to make student loan repayment more manageable.
Go on an income-driven repayment plan (IDR)
If your federal student loan monthly payments are high and you want to lower your student loan payments, you can opt for an IDR plan. These repayment plans allow you to make low payments that are based on a small percentage of your income.
Under the various IDR options, you can pay 10% to 20% of your monthly income toward your student loans with repayment terms of 20 to 25 years. A longer term means smaller monthly payments over time, but you’ll pay more interest in the long run.
If you still have a balance at the end of your term, you’re eligible for loan forgiveness. However, you might have to pay taxes on the forgiven amount (though this is waived until the end of 2025).
Opt for PSLF if you work in the public sector
If you work in the public sector, you might qualify for student loan forgiveness under the Public Service Loan Forgiveness program (PSLF). Under PSLF, you need to be on an IDR plan, so your payments are already based on a low percentage of your income. You must make 120 payments and work for 10 years in the public sector to qualify.
Loan forgiveness eliminates your student loan debt, freeing up cash that you can put toward your mortgage.
Use a PSLF calculator to see how much you can save through this program.
Refinance your student loans
A similar, but more straightforward, alternative is simply refinancing your student loans. You’ll still forfeit federal protections through this route, but you might save more money on interest without putting your home at stake.
Plus, you can take advantage of cash-back refinancing bonuses and other perks that private student loan lenders offer.
These alternatives are generally a safer option to pay down your student debt.
A student loan cash-out refinance can be a convenient way to manage monthly debt payments, but it has major drawbacks. If you’re considering a student loan cash-out refinance, check your home’s equity and crunch the numbers to see if it makes financial sense for your situation.
Deciding whether it’s wise to refinance your home mortgage to pay off student loans, can be an overwhelming decision. If you need help learning about all of your student loan repayment options and viable refinancing strategies, get in touch with a consultant.