Buying a home is usually the most expensive purchase in a parent’s life. However, paying for college for their children can be a close second, and the price of college is rising faster than the price of housing. So, does it matter what the value of your client’s home is when shopping for colleges? Can they use the equity they have in their home to their benefit? How does home equity impact financial aid?
First, a disclaimer…for most college students, it doesn’t affect financial aid.
The vast majority of colleges do not ask about or care how much home equity your clients have in their house and will not be benefited by using their home’s equity in some way to pay for college. (We’ll talk about borrowing against their home equity here in a bit.) The FAFSA used by almost all colleges does not ask about a home’s value or mortgage against the property in calculating financial need. It simply is not part of the conversation.
Be sure to note that we are talking about a family’s primary residence here. If a family owns additional real estate, the net equity of those properties will be included in calculating their expected family contribution and financial aid need. The primary residence where the family lives every day is not included.
Which colleges care about your house?
Currently, nearly 400 colleges, professional schools, and scholarship programs use CSS Profile to award non federal aid. Because they aren’t adhering to federal rules for determining need, colleges are freer to look at more aspects of a family’s finances. Most of these colleges are private and may have large endowments to provide aid to students in need.
Colleges are trying to figure out how much your client can afford to pay, and they will look at not only assets but also expenses. So, does your client have a large mortgage? Do they have a valuable asset, their home, that can be tapped to help pay for college? They might not want to think of their home as a piece of the puzzle, but colleges may want to use those numbers in their bigger picture to try and truly grasp the need of any particular student.
You can read a more detailed analysis of financial need methodologies in this blog article. Families should note that some colleges cap the amount of their home’s value at a certain percentage of their income while others may have no cap and assess the value at the full parent asset rate used (5%). This blog post lists some schools that either do not consider home equity, consider it but cap it, or consider it but don’t cap it.
Have your clients take advantage of their situation.
If your client’s student is academically talented enough to be admitted to one of these more exclusive schools and their home ownership does not take their student out of the running, they can take advantage of their financial situation. The key is knowledge. Your college search can be impacted by that knowledge. A good idea if they are unsure is to make a quick phone call to the financial aid office at the college they are interested in.
Now, let’s look at home equity loans to help pay for college.
We actually dug deep into this topic in a previous blog post. Here’s what we had to say (we’re repeating ourselves, but it is important stuff to know!):
A home equity line of credit (HELOC) is money that can be borrowed against the value of your home minus any other outstanding mortgage amount. In order to qualify, consumers must have enough equity in the home, a high credit score, and a good debt to income ratio. For HELOCs, typically lenders want the loan to value (LTV) to be 80% or less.
A HELOC is a mortgage with a revolving balance, like a credit card, with an interest rate that varies with the prime rate. Your clients only access the funds that they need when they need them. For consumers with good credit the interest rate available via a home equity line of credit may be more favorable than the rate from a Federal Parent PLUS loan or a private student loan.
The danger of a HELOC
Here’s the deal, does your client want to put their home at risk to pay for college? The Parent PLUS loan may have a higher interest rate, but it comes with some perks like loan deferment and flexible repayment options that a home equity line of credit does not.
A home equity line of credit should only be used for small funding gaps. This advice is the same guidance we give for the Parent PLUS loan–only use it to cover a small gap.
Also, be aware that if your client takes out a home equity loan or line of credit and the money is in their bank account when they complete the FAFSA, it will be counted against them as an assessable asset in the financial aid calculation. Those who may be eligible for need-based financial aid do not want the money from their home to be sitting in their bank account when they fill out the FAFSA.
Important to note with the changes to the tax code starting in 2018, loan interest on a home equity line of credit will no longer be deductible on federal taxes. However, some tax filers depending on your client’s Adjusted Gross Income may claim up to $2,500 in interest paid on federal student loans. This deduction can be claimed without itemizing.
The big picture
Your client’s home can be part of the bigger paying for college picture. If the situation is right, it might be a part of the puzzle for finding the best school at the best price. It is important to be aware of its impact though. Parents need to stop and consider how their $500,000 home will impact their child’s aid from a college like Northeastern or Tulane who will add $25,000 to a family’s Expected Family Contribution!
Paying for college and funding a comfortable retirement is a delicate balance. Our goal for each of our clients is that they be mortgage free by retirement. Be extremely cautious of using home equity to pay for college and robbing your retirement.