December 18, 2020
How A Cash-Out Refinance Could Help You Pay Off Student Debt
Good news, as of Friday, December 4, the U.S. Department of Education extended the pause on student loan repayments put into place as a result of the coronavirus pandemic through January 2021. That means if you have student loans, you don’t have to resume payment until February of next year. The average student loan payment is $400 a month (Federal Reserve Bank of NY).
If you’re one of the many Americans who has student loan debt (approximately 45 million borrowers in the US), but want to purchase a home, you can do it! Check out our article, How to Buy a Home When You Have Student Debt. If you’re already a homeowner, but have student loans and are preparing for the repayment plans to restart in February, you may be able to use a cash-out refinance to help pay your debt down.
For Homeowners
It’s no secret that mortgage interest rates are low right now. But refinancing may seem like a foreign or intimidating concept. So let’s start with what is a cash-out refinance? A cash-out refi allows you to access a portion of your home's equity and turn it into cash. It replaces your existing mortgage loan with one that is greater. The difference goes to you in cash to use as you like. It’s a way for you to get cash from your home without selling it.
You can use this cash for anything, but because you may be subject to additional fees and a new interest rate, it’s best to use the money smartly, like paying down high-interest debt.
Pros of a Cash-Out Refinance
Things to Consider With a Cash-Out Refinance
For Future Homeowners
If you’re looking to purchase a home, but are currently paying off student loans (or are preparing to commence after the forbearance period ends), keep reading.
Let’s demystify the assumption that you need to be completely debt free to qualify and apply for a mortgage. Lenders don’t necessarily look down upon debt - what’s more important is your debt-to-income ratio (DTI). Your DTI is a comparison of the money you owe vs the money you bring in. If your DTI is low enough, it shows that you can manage your debt well and taking another debt like a mortgage loan is possible.
Take a look at how your student loan debt compares to your overall debt and total income. Depending on how much of your student loan you have left to pay off, you may have a higher DTI and need to spend time paying down that loan.
But you don’t need to completely pay off your student debt to qualify for a mortgage. Other factors are just as important such as reliable income, credit score, other debt management history, and potential down payment savings.
If you’ve acquired a stable job and have developed smart money habits: if you have an emergency fund, a low DTI, you’re saving for retirement, and you’re on a solid student loan repayment plan, you might be ready to become a homeowner!
Consider your options. If you do have a higher DTI because of your student loans, you may not qualify for a conventional loan, but rather a government-backed loan. Research different loan types and talk to a mortgage professional to explore your options.
Pay off other debt. If you have other debt like credit cards on top of your student loans, focus on paying that down too, to lower your overall DTI. You can still work towards buying a home while you pay down your debt.
While there are possibilities for another stimulus check, an extension of the student loan pause, and even some loan forgiveness from the new administration, none of that is certain. It’s best to assume that loan payments will resume in February as currently stated and plan your 2021 financials around that. Any changes will be a welcomed bonus! But know that homeownership is a possibility for you even if you’re managing student loans!