There is a new viral video going around in which presidential candidate and Vice President Kamala Harris recommended that people take out home equity loans to send their children to college. That is a bad idea.
I’ll share the obligatory disclaimer that this isn’t a political criticism; we all know that politicians on both sides of the aisle come out with some “interesting” ideas. I’m sure she believes it’s a good idea, but there are definite problems with this recommendation.
Let’s first look at what she said: “We know that is probably the most effective way to build intergenerational wealth.” So far that sounds reasonable. She goes on to say “As a parent then, as a homeowner, if you have some equity in your home, you can say to your child, you know, don’t take out the loan, I’ll take out some of the equity to help you pay for tuition. So that you don’t graduate with extraordinary student loan debt.”
There are several problems with this advice to use a home equity loan to fund your child’s education.
Deductibility
As most of us know, student loan interest can be deductible for the payer of the loan. On the other hand, interest on a home equity loan is generally deductible only when the money is used to buy, build or substantially improve the home that secures the loan.
If you take out a student loan, you can deduct up to $2,500 in annual interest (subject to income limitations and other restrictions). That means someone who paid $2,500 in interest on student loans could save $550 per year by deducting it if they are in the 22% tax bracket, a deduction that is not an option for the parent who takes out the home equity loan..
Student Loan Forgiveness
This is another politically charged topic, but it’s undeniable that there is controversy surrounding whether or not the government should forgive student loans. Some think it’s a great idea, while others believe it’s unfair to those who didn’t attend college or who have already repaid their loans. You are entitled to your opinion on this, but we can all agree that if you take out a home equity loan, and student loans are forgiven, you will have missed the opportunity to have your loans forgiven. I haven’t heard anyone in either party suggesting that home equity loans should be forgiven. So, if you could have had a $100,000 student loan forgiven, but instead took out a $100,000 home equity loan, you’re likely stuck with that loan whether or not student loan forgiveness indeed occurs.
Variable Interest
Just like student loans, home equity loans have a variable interest rate. If interest rates rise, your home equity loan rate will also increase. There are often lower rates and subsidized loans available for students, where interest can be deferred or may not accrue until after graduation. With a home equity loan, interest charges begin immediately.
Foreclosure
While a home equity loan won’t put many of us in this situation, job loss or other financial difficulties could lead to trouble repaying the loan. If this happens, your home could go into foreclosure, and the bank could take it back, leaving you without one of your largest assets. Of course, the bank plans to sell the home, and you’ll receive any proceeds that exceed the loan amount. But you’ll still need to find another home and deal with current mortgage interest rates. Do you think it would be easy to get a mortgage for a new home after a foreclosure? It will be even more difficult if you’re also unemployed.
Your Retirement Impaired
We’ve all heard the airline attendant’s warning to “put your own oxygen mask on first, then your child’s.” This applies here. Taking out a large loan to fund your child’s education can impact your ability to retire when you want to. For many people, a mortgage payment is one of their largest expenses, and paying off their home is essential for retirement. A significant loan on your home could set you back years. On the other hand, your child will likely graduate in their early 20s and have 40 years to pay off debt and plan for retirement, while you may have only 10 or fewer years to do so.
What About Paying Later?
I’m not advocating for or against paying for your child’s education; that’s a personal decision. However, consider this: What if your child takes out student loans, especially subsidized ones, and you help them financially after graduation? Or perhaps you plan to downsize your home later and can provide financial assistance at that time. If you can afford to help your children from funds not tied to your home, that’s going to be a much better option.
Disclaimer: This article is for informational purposes only and is not tax, legal or financial advice. Everyone’s situation is different, so consult a financial advisor.
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Photo, top, courtesy of Scott Webb / Pexels
