Student loan cash-out refinance: What to know

A student loan cash-out refinance allows you to use the equity in your home to pay off your student loan debt. Essentially, you combine your student loans and mortgage into a new loan. This helps you get rid of your student loans and potentially lock in a lower interest rate on your mortgage.

A cash-out refinance can be an attractive option to borrowers struggling to pay off their student loans, but this option comes with certain risks. If you’re considering a cash-out refinance to pay off your student loans, it’s important to understand how it works and the pros and cons of this choice.

• What is a student loan cash-out refinance?
• When to consider a cash-out refinance
• Types of student loan cash-out refinancing
• Pros of cash-out refinance for student loan debt
• Cons of cash-out refinance for student loan debt
• Frequently asked questions

What is a student loan cash-out refinance?

A cash-out refinance is a new mortgage that’s larger than your existing mortgage. You’ll use the loan to pay off your existing mortgage balance and receive any remaining funds as cash.

When you do a student loan cash-out refinance, you use the equity you’ve built in your home to pay off your student loan debt. You’ll take out a new mortgage for more than what you currently owe on your home. You’ll receive the difference as cash and use it to pay the outstanding balance on your student loans.

When to consider a cash-out refinance

A cash-out refinance allows you to use the equity in your home to consolidate debt or fund a major purchase. For instance, some borrowers use a cash-out refinance to pay down credit card debt or finance a home improvement project.

You can also use the money from a cash-out refinance to pay off student loan debt. A student loan cash-out refinance consolidates your debt by combining your student loans and mortgage into one loan. The goal is to lock in a lower interest rate and simplify your finances: You’ll have a single loan payment to keep track of rather than juggling multiple payment due dates.

A cash-out refinance is a good option if you can get a lower interest rate than you’re currently paying. The interest rate you’ll qualify for will largely depend on your credit score and the real estate market.

If you don’t want to roll your student loans into your mortgage but you’re having a hard time making loan payments, a cash-out refinance could provide funds to put toward paying down education debt.

Types of student loan cash-out refinancing

If you want to use a cash-out refinance to pay off your student loans, you can apply for a general cash-out refinance through your mortgage lender. Most lenders will let you use the funds for any purpose, though you should check before applying.

You can also apply for a student loan cash-out refinance through Fannie Mae’s Student Loan Solutions. It’s designed to help homeowners pay off their student loans using their home equity.

Pros of cash-out refinance for student loan debt

Here are some of the biggest benefits of using a cash-out refinance to pay off your student loan debt:

• Low interest rates: Mortgage rates tend to be lower than student loan interest rates. This is because home loans are secured with your property as collateral. By refinancing your mortgage to pay off your student loans, you could potentially save money on interest costs.
• Streamline your payments: By consolidating your debt, you’ll only have one monthly payment to keep track of. This can make managing your debt easier.
• Boost your credit score: With one payment date to keep track of, you might find it’s easier to make your monthly loan payments on time. Because payment history accounts for 35% of your credit score, this is a quick and easy way to boost your credit.
• Access to cash: A cash-out refinance lets you access the equity in your home, which can give you some financial flexibility.
• Possible tax deductions: Mortgage interest payments are fully tax-deductible, while student loan interest payments are only partially tax-deductible. By consolidating your student loan debt into a home loan, you may be able to deduct more of the interest paid.

Cons of cash-out refinance for student loan debt

While using a cash-out refinance to pay off student loan debt may be the right move for some borrowers, this strategy comes with risks. Consider these potential drawbacks first:

• More interest accrued overall: A cash-out refinance can lower the interest rate on your student loans. But when you refinance, you may end up with an extended repayment term. This means you could end up paying more over the life of the loan since you’re borrowing more money and taking longer to pay it off.
• Higher monthly payments: Refinancing your mortgage at a higher amount will increase your monthly payments. It’s important to think about whether you can afford the higher payments and continue to meet your other financial obligations.
• Loss of federal loan benefits: If you refinance federal student loans, you’ll lose access to certain benefits like income-driven repayment plans, loan forgiveness programs and forbearance options.
• Risk of losing your home: When you use your home equity to pay off your student loans, your unsecured debt turns into secured debt. That means if you’re unable to afford your mortgage payments, you risk losing your home.
• Closing costs: When you refinance your mortgage, you have to pay closing costs. These costs include appraisal fees and title insurance and usually cost between 2% to 5% of the loan amount.

Frequently asked questions

Here are some commonly asked questions about doing a student loan cash-out refinance.

What are the downsides of a cash-out refinance?

A cash-out refinance tends to come with higher interest rates than a traditional mortgage. And since the loan extends your mortgage repayment term, you’ll end up paying more interest over the life of your loan. Plus, you’re using your home as collateral, so you risk losing it if you’re unable to keep up with mortgage payments.

Is it hard to qualify for a cash-out refinance?

Qualifying for a cash-out refinance can be more difficult since lenders tend to have stricter requirements for these types of loans. When evaluating your application, your lender will consider how much equity you have in your home, your credit score, and your debt-to-income (DTI) ratio.

You’ll typically need a minimum of 20% equity in your home for a cash-out refinance. Additionally, you’ll need at least a 620 credit score to qualify with most lenders — but you may be eligible for a VA, FHA or USDA loan even with poor or fair credit. For home loans, aim to have a DTI ratio no higher than 43%.

What are some alternatives to a student loan cash-out refinance?

One alternative is to refinance your student loans through a private lender. Refinancing your student loans will help you streamline and lower your monthly payments without putting your home at risk.