“We need more cash to cover college: Is it a good idea to use a HELOC or student loans?” asked a client, recently. Amid rising tuition fees and increased uncertainty around the future of higher education funding, American families are seeking alternative strategies from conventional aid. Were I to send my kids to my alma mater, it would cost 35% more than when I attended, and that’s after accounting for inflation. Parents have gotten creative in financing these rapidly inflating college expenses. Enter the HELOC (Home Equity Line Of Credit), which requires the use of home equity to secure financing, but potentially reduces borrowing costs, albeit at substantial risk.
Understanding What A HELOC Is And How It Works
Not to be confused with a home loan (also known as a home equity loan), a HELOC is a revolving credit account homeowners can use to borrow against the equity in their homes. Think of it like a credit card where you’re borrowing money, only you’ve put up your home as collateral to get a reduced rate. Interest is usually charged only on the amount borrowed and, while most HELOCs have floating rates, some lenders may offer the option to lock in a fixed rate over some set period of time. This flexibility can make a HELOC an attractive option for managing cash flow or handling unexpected or “lumpy” expenses like tuition payments.
It’s easy to confuse a HELOC with a home equity loan. Unlike the HELOC, a home equity loan gives you a fixed sum of money you repay over time at a fixed rate. The HELOC’s flexibility may be a better fit for families facing unpredictable costs, whereas a home equity loan is more appropriate for known, one-time expenses where the homeowner prefers a steady, predictable repayment at that fixed rate.
Should You Use A HELOC To Fund College?
The top reason students choose a particular school is due to cost, according to Sallie Mae’s 2024 How America Pays for College study. While the majority of families receive some form of aid, scholarships and grants only made up about 27% of higher education funding for the average American family in 2024. Higher education has never been less affordable than it is today. The traditional avenues of federal aid and conventional student loans are limited and under threat by the current political environment. Against this backdrop, families are looking for alternatives that offer competitive or lower interest rates and flexibility without relying on federal aid.
Just like with home equity loans, interest on student loans is fixed, meaning their interest rates don’t change over the life of the loan. By contrast, HELOC interest rates float, which can be good or bad depending on how their rates fluctuate over time and your capacity to meet shifting bills. For example, your rate may start at 8%, go up to 10% or down to 6%, making it difficult to plan for ongoing payments.
That said, HELOC rates may be competitive with many student loan rates, and are usually substantially lower than personal loans. In addition, the “as needed” nature of a HELOC means that families can withdraw funds as needs arise. This makes a HELOC particularly advantageous given the fluctuating costs associated with college. Tuition and fees might not change dramatically in a four year period, but textbooks, living expenses, supplies, room, and board are subject to wider swings.
HELOCs can also provide a buffer for cash flow. Rather than depleting savings or tapping into retirement funds prematurely to meet a sudden expense (thank you, year abroad), parents can manage expenses on an as-needed basis, aligning their borrowing more closely with their child’s actual financial needs over time. In turn, this approach helps maintain financial stability and preserves other critical assets.
Risks Of Using A HELOC For College Expenses
HELOCs can be an attractive option given low rates and their “borrow as you go” versatility, but there are several substantive risks that should be considered. HELOCs are secured by your home, so any unexpected financial challenges like job loss, an economic downturn, or rising interest rates can put your primary residence at direct risk. Unlike federal student loans, if you miss your HELOC payments lenders have the right to initiate foreclosure proceedings.
Further, HELOCs are subject to floating interest rates tied to the “prime rate.” The prime rate is usually about 3% higher than the Federal Reserve’s “fed funds rate,” the interest rate banks charge each other when lending overnight to meet reserve requirements. This is the rate you often hear about in the news that the Federal Reserve uses to combat inflation or to stimulate the economy.
While current HELOC rates may be modest compared to those of private student loans, because they fluctuate it can increase borrowers monthly payments unexpectedly. If unprepared, HELOC borrowers may find a previously inexpensive loan has rapidly become unaffordable. When borrowing through a HELOC be sure to budget for potential rate hikes even if current rates seem favorable.
Further, almost half of Americans rely on the equity in their home during retirement, according to the U.S. Department of Housing and Urban Development. Borrowing against your home equity for a child’s college may put future borrowing capacity at risk, leaving you vulnerable to emergencies later on. This is especially true of those payments become difficult to manage.
Lastly, HELOCs lack the current borrower protections available with federal student loans. HELOCs don’t offer IDRs (income-driven repayment plans), forbearance, or deferment options in times of financial hardship. There are no adjustable terms during difficult periods for HELOC borrowers. While some student loan forgiveness programs are threatened by the current administration, there are many types of IDRs, and not all of them are on the chopping block. Keep in mind, too, that HELOCs are not a substitute for student loans, but a complement, and that a combination may be the preferred option.
For example, imagine you have substantial home equity and elect to fund college expenses via a HELOC. Everything goes fine at first, but a shift in market conditions leads to a sharp rise in interest rates. The family’s monthly obligations increase and funds are diverted from emergency funds at first, then retirement accounts just to manage the new payment demands. There is a delicate balance between seizing short-term opportunities and safeguarding long-term financial security. Remember: You can borrow for college, but you can’t borrow for retirement.
Legal And Tax Implications
If you’re considering tapping into your home equity to fund college expenses there are legal and tax issues you’ll need to know. Unlike conventional student loans governed by federal guidelines, HELOCs are governed by the terms set forth by your lender and the underlying mortgage agreement. These contracts are legally binding, meaning that any lapse in payment can result in severe consequences, such as foreclosure. Because your home is collateral for the HELOC, you need to review the fine print, paying close attention to anything related to default, prepayment penalties, and any restrictions on how the funds can be used. If it feels overwhelming you might want to consult with a real estate attorney to have the language and risks of your particular HELOC offer explained plainly.
On the tax front, recent legislative changes have redefined the boundaries of what constitutes a tax-deductible expense. Traditionally, interest on home equity debt could be deducted if the funds were used for home improvements. However, when HELOC funds are used for other expenses like tuition and other education-related costs the interest loses its deductibility. A HELOC still might make sense due to its lower interest rates, but consulting with a tax professional current with IRS guidelines is a good idea before making a commitment, as mistakes in interpreting IRS rules can lead to costly audits or unexpected liabilities.
Keep in mind, too, that the application process for a HELOC requires extensive documentation. Borrowers usually need to provide comprehensive records like property appraisals, income verification, and reports of existing debts and financial obligations. This is so that the lender can evaluate your candidacy as a borrower, but the process also ensures you’re fully aware of your financial commitment. Keep meticulous records and understand the legal structure of your agreement to protect against any potential disputes arise later.
Ultimately, while a HELOC may offer a flexible funding option for college expenses, savings and student loans are typically the preferred funding option. HELOCs are more of a consideration if there is a funding gap and, even then, should only be considered in the context of your financial strength over the long term. If you’re putting your home at risk, you might want to reconsider the importance of funding higher education. Consider instead deferring the education, transferring to a lower-cost institution, or seeking alternate funding (applying for alternate aid, direct personal loans, etc.). If you still have doubts, consider speaking with professionals that most closely align with your personal financial situation, whether it be a financial or legal consultant to ensure you have explored every option before putting your home and financial well-being at risk.
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