Fannie Mae has unveiled a new program that allows borrowers to directly pay off outstanding student loans by refinancing their homes. For some, it might be an expedient way to consolidate debt at a lower rate.
But consumers should be cautious about taking the leap, says Rohit Chopra, senior fellow at the Consumer Federation of America.
The program works like this: Homeowners refinance their house, and the bank sends the money to the student lender to completely pay off at least one loan. With current interest rates for home refinancing under 4 percent, it could be a money-saving move, especially for borrowers with student loan interest rates topping 7 percent.
Chopra, however, advises those considering such a loan to consider the trade-offs before signing.
By moving debt from a student loan to a home loan, you give up some important protections. Student loans generally allow the option of an income-driven repayment plan or a deferral for financial hardship; mortgages do not. Only higher-income borrowers with stable jobs, therefore, should even consider such a move.
“Once you refinance and put it into your mortgage, you’re putting your house at risk,” Chopra says.
While the precise definition of “higher income” varies depending on individual financial circumstances, there are some rough guidelines. The income-based repayment program caps student loan payments at 10 percent of income. So if you are currently paying significantly less than that sum, you could be a good candidate.
In addition, single taxpayers with incomes of more than $80,000, and married filers making more than $160,000, are not eligible for a student loan interest deduction. But the mortgage interest deduction does not begin phasing out until you reach a much higher income level. That means moving your debt begins to make more sense as you pass the $80,000 or $160,000 threshold.
Chopra expects the first customers for these new products will be parents who took out loans to pay for their children’s education. These borrowers are more likely to be paying high interest rates and have plenty of home equity.
Chopra says “the jury is still out” on whether the program is a good thing. “New products and financial innovation can help borrowers save money,” he says, “but they can also be prone to abuse.”Have a consumer question or complaint? Reach Sarah Shemkus at firstname.lastname@example.org.