HELOC vs. Student Loan: Which Should You Use to Pay for College?

Paying for college is a complex puzzle for most families. Over 40% use borrowed funds, and 70% report making lifestyle changes to tuck away extra cash for higher education.

Regardless of your personal finances, a creative approach can help lower costly tuition bills. Chances are you’ve considered federal student aid and private loans¹ – but did you know you could tap into your home equity via a HELOC to fund your child’s education? When it comes to HELOCs vs student loans, there are some distinct differences and disadvantages. Which fits your family’s financial goals better? Let’s explore.

What is a HELOC?

A home equity line of credit (HELOC) is a second mortgage that allows homeowners to access cash by borrowing against the value of their home. A HELOC is a secured loan because it’s backed by the equity in your home.

There are generally two main types of HELOCs: Variable-rate HELOCs have rates that change in accordance with national interest rates, and fixed-rate HELOCs have interest rates that are set at the beginning of the loan and remain constant throughout.

How does a HELOC work?

Unlike other types of loans (including home equity loans) that give borrowers a lump sum, HELOCs function similarly to credit cards. A HELOC is a revolving line of credit, allowing you to use only the cash you need when you need it. And like a credit card, you’ll only pay interest on the amount you use.

HELOCs have two different phases. The first phase of your HELOC is the draw period. During this time, you can withdraw funds from the line of credit while only making interest payments.

The second phase is the repayment period. During this phase, you’ll begin to pay back the principal amount borrowed plus interest, similar to the repayment structure for an amortized loan. At this point, you can’t continue to withdraw from your line of credit. Your ability to borrow more money ends when the draw period ends.

The length of the draw period varies but is usually between five and ten years. However, some draw periods can last up to fifteen years, depending on the lender. The repayment period is generally longer. While the exact length depends upon the terms of your HELOC, typically the repayment period lasts between ten and twenty years.

How much can I borrow?

The amount you can borrow varies based on the value of your home and how much equity you have in it – meaning how much of your mortgage you’ve paid off. To be eligible for a HELOC, you’ll need to qualify in a few areas.

You must have a healthy debt-to-income ratio.

You should have a good credit score.

The value of your home must be greater than the amount you owe on your mortgage.

Use a HELOC calculator to estimate how much you can borrow and the price of your monthly payments. Typically, homeowners can borrow between 85 to 90% of the value of their home after subtracting their outstanding mortgage balance.

Can I use a HELOC to pay for college?

Yes, you can use a HELOC to pay for college. HELOCs give borrowers access to cash, which can be used for anything from financing your education to making home improvements. While most homeowners use HELOCs to invest in their home, it’s totally acceptable to tap into the value of your home to cover tuition, textbooks, housing costs, or any other college-related expenses.

Pros and cons of using a HELOC to pay for college

For some families, a HELOC could be the right approach to free up cash to cover college expenses while avoiding student loan debt. For others, it might feel too risky to stake the family home on a child’s college education – particularly for parents on the fence about whether or not they should pay tuition bills. Here are some things to keep in mind when you’re exploring a HELOC to pay for college.

Pros

Can carry lower interest rates

HELOCs often have lower rates compared to private student loans, which could save you money on interest in the long run.

Can carry manageable monthly payments

If you secure a HELOC with a fixed interest rate, you could access steady, manageable monthly payments that don’t change. While the total interest paid might be higher over the course of a 20-year HELOC, paying back the loan over a longer period of time allows you to have lower monthly payments that might be more comfortable for your budget.

Use only as much as you need

Student loans award a lump sum to borrowers and then require repayment with interest on that entire amount. But with a HELOC, families can borrow only the exact amount of money needed. This flexibility can be helpful if you don’t know how much a child’s college education will cost. Additionally, instead of paying interest on a single lump sum that you may or may not use, HELOCs allow borrowers to only pay interest on the money they use.

Interest-only payments

During the draw period, borrowers will only be responsible for monthly payments to cover the interest portion of the loan – not the principal amount borrowed.

Cons

Minimal protections

Unlike federal student loans which offer a number of repayment options like income-driven repayment and federal protections like loan forgiveness, HELOCs don’t. Even if your financial situation changes, you’ll still be required to repay the amount borrowed. Though a HELOC may be a good alternative to a private student loan, in general, you should take out federal student loans before considering a HELOC.

Potential for foreclosure

Taking out a loan against the value of your home is a high-stakes bet. If you are unable to repay the loan, you could risk losing your home through foreclosure.

Could affect FAFSA® eligibility

While home equity is not directly included in the FAFSA® calculation for determining your expected family contribution (EFC), funds withdrawn from a HELOC and held as cash or invested may need to be reported. These funds could affect your child’s eligibility for need-based financial aid. Check with the financial aid office at your child’s university.

Higher interest rates compared to federal student loans

While many HELOCs have lower rates than private student loans, their rates can be higher than federal student loans.

Prepayment penalties

If you want to pay back the loan balance on your HELOC faster than your established repayment terms, you could face a prepayment penalty. Lenders charge these fees to recuperate a portion of the amount they expected to earn via interest. But not all HELOCs come with these fees – read the fine print to understand the terms of yours. Watch out: these penalties can also be called “early closure” or “early termination” fees.

Closing costs

Most homeowners expect to pay closing costs with their primary mortgage but might not consider that HELOCs can carry closing costs, too. These costs vary by lender. Depending on how much money you plan to borrow, these fees might be tough to stomach.

Ineligible for tax deductions

HELOCs and home equity loans are popular because there is a tax deduction available for interest paid on these loans. But the IRS only offers this tax deduction for homeowners using a HELOC to make home improvements. Unfortunately, using this money to pay for college won’t garner any tax deductions.

Should I use a HELOC to pay for college?

Maybe – but probably not. There are certain situations where using a HELOC to afford your child’s education could be advantageous. But for the majority of borrowers, student loans likely make more sense. If your family is eligible for federal student loans, you should borrow them first. Federal student loans come with the greatest number of borrower protections, can be eligible for consolidation, and carry low, fixed interest rates. In short, federal student loans tend to be the safest, most cost-effective option for the average family.

However, if you’ve maxed out your federal loans and are considering a Parent PLUS Loan or a private student loan, a HELOC could be a better option. Or, if you’ve paid off a significant portion or all of your home and aren’t eligible for federal student loans, a HELOC could provide helpful cash at a lower interest rate than a private student loan. But because HELOCs carry the potential risk of home loss through foreclosure, spend some extra time to ensure this is the right option for you. While defaulting on student loan payments is never a good idea, it doesn’t usually result in home foreclosure. But with a HELOC, your inability to keep up with monthly payments could bring about that worst-case scenario. For this reason, a HELOC is recommended only for the most financially stable of borrowers.

Alternatives to using a HELOC to pay for college

If a HELOC doesn’t seem like the right choice for your family, there are a number of great options to make your child’s college education more affordable.

Private student loans

Private student loans are loans offered by private lenders, such as banks or credit unions, to help students and families finance a child’s education. Unlike federal student loans, which are funded by the U.S. Department of Education, private student loans are provided by private institutions like banks and credit unions. While they can carry less favorable terms than federal student loans, private loans are a great resource for families who might not be eligible for federal loans, those who have a gap between their federal loan offerings and tuition, and others who might need to borrow more than their federal loans offer to cover costs like housing, travel, and other educational expenses. Oftentimes, private student loans require cosigners or credit checks.

Parent PLUS Loan

A Parent PLUS Loan is a type of federal student loan that is specific to parents or legal guardians of dependent undergraduate students. Unlike other federal loans, borrowers must have good credit history to qualify and the loan is not based upon financial need. Parent PLUS Loans offer fixed interest rates as well as all of the borrower protections of other federal loans like flexible repayment plans and eligibility for student loan forgiveness if consolidated. However, this loan cannot be transferred to your child through the federal government – so think through your financial goals (particularly your retirement planning) before taking on debt on your child’s behalf. Interested in how other parents approach funding their child’s college education? We’ve compiled some research on the topic.

Scholarships

Unlike all of the loan options mentioned above, scholarships are free money that will never have to be repaid. They can be a lucrative funding source to help many students reduce their overall costs. And if you thought scholarships were only for straight-A students or skilled athletes, you’ll be surprised to learn that there are scholarships available for students of all types and scholarly ambitions.

Get matched to scholarships with Going Merry

Continuing education and pursuing a bachelor’s or graduate degree can lead to higher future earning potential and a more fulfilling career. But first, you’ll have to figure out how to pay for it. From federal loans to private loans to HELOCs, there’s no shortage of borrowing options and financial aid resources. It’s up to you to determine what’s best for your personal finances and your family’s financial goals. One great resource regardless of your bank account balance? Scholarships.

Going Merry is your one-stop shop for financial aid resources and scholarships. We curate and vet thousands of lucrative scholarship programs to help your family offset the cost of college. As a parent, you can browse our extensive database, create a profile, and help your child get matched to personalized, hand-picked awards. Sign up for Going Merry and gain access to high-quality scholarships to help your child realize their educational goals.

Disclaimer: This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

1 Before applying for private student loans, it’s best to maximize your other sources of financial aid first. It’s recommended to use a 3-step approach to assembling the funds you need: 1) Look for funds you don’t have to pay back, like scholarships, grant and work-study opportunities. 2) Next, fill out a FAFSA(R) form to apply for federal student loans. Federal Direct subsidized and unsubsidized loans, excluding PLUS Loan for Parents and PLUS Loan for Graduate and Professional Students which require a credit check and a credit worthy endorser if the parent or graduate or professional student has adverse credit, do not require a credit check or cosigner, and offer various protections if your struggling with your payments. 3) Finally, consider a private student loan to cover any difference between your total cost of attendance and the amount not covered in steps 1 and 2. For more information, visit the Department of Education website at https://studentaid.ed.gov.

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Going Merry is a one-stop shop for scholarships-- allowing students to find and apply for scholarships, right on our platform. It's like the best scholarship search engine, and an efficient scholarship application form, all in one. How does it work? You fill out a profile, get matched to scholarships you're eligible for, and then can filter or favorite scholarships into an application shortlist. Then, when you're ready to apply, our platform auto-fills any information you've already told us, so that you never have to answer the same thing twice. Counselors often call us the "common app for scholarships."