How does home equity impact financial aid?
By Joe Messinger, CFP®
July 15, 2018
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 home is when shopping for colleges? Can you use the equity you have in your home to your 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 you have in your house and you will not be benefited by using your home’s equity in some way to pay for college. (We’ll talk about borrowing against your 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 your 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 you can afford to pay, and they will look at not only assets but also expenses. So, do you have a large mortgage? Do you have a valuable asset, your home, that can be tapped to help pay for college? You might not want to think of your 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 your home’s value at a certain percentage of your 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.
Take advantage of your situation.
If your student is academically talented enough to be admitted to one of these more exclusive schools and your home ownership does not take your student out of the running, you can take advantage of your financial situation. The key is knowledge. Your college search can be impacted by that knowledge. A good idea if you are unsure is to make a quick phone call to the financial aid office at the college you 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. You only access the funds that you need when you 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, do you want to put your 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 you take out a home equity loan or line of credit and the money is in your bank account when you complete the FAFSA, it will be counted against you 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 your federal taxes. However, some tax filers depending on your 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 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.