You’re getting ready for one of your children to leave the next and embark on the next big adventure: a college education! When it comes time to pay for higher education, what happens if you don’t get the financial aid you expect? Can home equity affect your financial aid, and can it be one solution to paying for college? We’ve got the details you need to know.
How Do Colleges Determine Financial Aid?
Some colleges require different applications to consider your child’s financial aid package. Understanding the differences between them can help you create your best plan to finance your child’s education.
Nearly every college and university in the country requires the Free Application for Federal Student Aid (FAFSA) to calculate financial aid. You need the FAFSA for Federal loans like a Stafford loan. Many colleges use this form as their guideline for their own scholarships, grants, and work study offerings as well.
You’ll need your and your child’s Social Security numbers to apply, as well as financial documents, including the following:
- Income tax return
- Bank statements
- Investment information
- Records of untaxed income and gifts, if applicable
The financial information you provide determines your Expected Family Contribution (EFC), or the amount you’re expected to pay. If you have multiple children in college, the EFC splits between them.
The FAFSA doesn’t ask about your home equity (although if you own real estate other than the house you live in, you’ll include those assets).
Nearly 400 colleges and universities use the College Scholarship Service (CSS) Profile for non-federal financial aid, like institutional grants and scholarships.
The CSS Profile includes home equity, small businesses you run, and other assets that the FAFSA doesn’t. If you’re divorced, the CSS Profile still requires financial information from all parents and guardians (including step-parents). The FAFSA only requires financial information from the parent the student lived with the most in the last 12 months. The schools your child is applying to may add their own questions about your family finances, as well. These variances can lead to big differences in how much financial aid each school offers.
Does Home Equity Hurt Financial Aid?
Sometimes it can feel like you need an advanced degree to catch all the nuances of how colleges use the CSS Profile. Some schools consider 100% of home equity as an asset when they calculate financial aid, which can cut deeply into how much need-based aid they offer. Other colleges or universities set their own income-based cap, usually 1.2 to 4 times the family’s annual income. And still other colleges don’t factor home equity into their financial aid equation at all, even if the CSS Profile includes this information.
Colleges and universities can change their financial aid calculation standards year-to-year. Stanford University announced in 2018 that it wouldn’t consider home equity for financial aid calculations anymore. The best way for you to get the most up-to-date information is to contact the financial aid offices of the schools you’re considering.
Here are the main takeaways you need:
- If your child is applying to a school that only needs the FAFSA, your home equity is not a factor in determining aid.
- If a college uses the CSS Profile, they may be considering your home equity as an asset, they may not, or they may only consider a portion of your equity based on your income.
- If a college does consider your home equity, then it’s possible that high home equity could lead to less financial aid.
Should I Use Home Equity to Pay for College?
If high home equity is hurting your financial aid eligibility, is converting some of that equity to cash a good solution to pay for college?
Let’s be totally clear: draining your home equity to pay for your child’s college is not a wise course of action! Your home is one of your most important assets. You need a plan that helps you put your child through school without incurring too much debt, and that respects other vital parts of your life, like your home. It’s always wise to start by consulting a financial advisor who specializes in helping families navigate higher education expenses.
Home equity loan vs. HELOC
There are two traditional options to accessing home equity funds. One is a home equity loan. The other is a home equity line of credit, or HELOC. A HELOC does not give you money up front but allows you to draw from home equity the same way you’d use a credit card. Colleges may count home equity loan funds as an asset, but loans may come with better interest terms than HELOCs.
Home equity sharing
Many homeowners are familiar with loans and HELOCs, but not everyone knows that there are more options for home financing.
The way home equity sharing works at Noah is that we invest in your home. Think of us almost as another member of your household (who doesn’t visit and eat all the good snacks). You get cash in exchange for our share in the future appreciation of your home equity, which you can use for any goals you choose. You won’t add debt to your profile or have to make monthly payments. Instead, Noah gets a share when you sell or refinance your home, or in a cash payment at the end of your term. If your home increases in value, fantastic! We’ll celebrate that win with you and take a proportionate share of the home’s appreciation. If your home drops in value after our Initial Term period with you ends, we’ll be partners through that loss, too, and share in the depreciation.
Home equity advantages and disadvantages
If you’ve already planned on paying for college with a combination of funds from 529 savings, personal savings, smart budgeting, and financial aid including student loans, home equity can be one additional option to close any funding gaps. As with any major financial decision, your best plan for success is to consult a professional for customized advice, and understand the pros and cons.
Some potential benefits of using home equity funds are:
- Lower interest rates. As of February 2020, average home equity loan interest rates are 7.12%. Federal Stafford loan interest for undergraduates is currently 4.53%, and the Direct PLUS loan interest is 7.08%. Many private student loans set interest rates substantially higher. Depending on your creditworthiness and other factors, you may find that a home equity loan sets more favorable interest terms than some student loan options.
- No interest. Home equity sharing agreements like Noah may come with no interest or monthly payments at all.
- More borrowing power. Federal loans set a limit of $5,500 to $7,500, depending on year of school. Accessing home equity can help if you need more than Federal loans offer.
- A carefully planned home equity loan might be preferable to taking a retirement distribution early (and incurring heavy penalties) or saddling a student with a large amount of high-interest private student loan debt.
- Noah has a Homeowner Protection program, which enables us to pay mortgage or property taxes for a limited time for qualified homeowners we work with. Finding lenders or financing partners who have a plan for unexpected financial challenges may help you feel more confident about accessing part of your equity.
Some drawbacks you should consider before taking out any home equity for college expenses include:
- You could be putting your house on the line. Ultimately, failure to pay a lender could lead to you losing your house.
- Some home equity loans set rigid terms, even if you find yourself handling unusual hardship later. If you’re exploring loans, talk to lenders about their flexibility to pause repayment requirements or otherwise help you out if you hit a financial bump in the road.
- Home equity interest is no longer tax-deductible. The Tax Cuts and Jobs Act of 2017 put a hold on home equity interest deductions, at least until 2025.
The home you raised your family in might also help your children launch their journey as new adults in college. If you consider options and set a responsible plan, home equity might be a useful way to pay part of college expenses.