5 Questions To Ask Before You Borrow to Pay Student Loans

Dirty Money
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Americans are now faced with student loan debt that tops $1.2 trillion. More than 70 percent of U.S. college students who graduated in 2014 had to borrow money in order to obtain their bachelor’s degree, and among them, the average student loan debt burden was $33,000, making 2014 the most indebted class ever.

As the statistics show, student loan debt is a problem that too many graduates are facing. And the higher the debt burden, the higher the monthly payments. So what can be done? The best way to deal with student loan debt is by making higher payments each month and paying your burden down as quickly as possible. Unfortunately, for many that isn’t a realistic option. If it’s not a possibility for you, you may be considering borrowing money to pay off your student loans. Before you do, it’s crucial to consider all aspects — the positives and negatives — that come along with borrowing money.

To help determine what’s best for you, take a look at these various scenarios and the potential consequences that come along with borrowing money to pay off student loans.

1. Should I borrow money from my family?

You likely had your mom or dad act as a cosigner on your student loans (although it could be any family member who was willing to put him or herself on the hook). Whoever cosigned your loan is probably the one you’d want to turn to in this situation, because that person’s name is on the loan, too. Let’s say you’re having trouble making payments on your loan. If your parents cosigned, it could affect their credit rating, and potentially even their ability to finance a house or car.

If you are struggling with student loans, you have an obligation to talk with them about it so they know what’s going on and what could potentially impact them. Here’s when you could consider a few different options: you could ask your parents (or other family members) to match your funds or supplement your student loan payments, or you could ask if they’d be willing to pay back your loan now and have you owe the money directly to them.

The positives: You will be free of your student loan burden, which is an undeniably great feeling. The negatives? You can end up passing that financial strain on to your loved ones. In a MSN Money article, Pauline, a mother with two college graduates, writes about the financial burden they now hold paying off their daughters’ debts. “We are taking out of our savings, (about) $3,000 monthly to pay our bills in hopes of things getting better. My husband handles the finances (and) says if we can get lower payments, it won’t matter on the student loans, we still have to pay forever. … He isn’t or can’t think about retirement,” she said.

Will this be the case for everyone? No. Some parents or family members will be in a better financial position to help you, but make sure they are before placing this responsibility on them. Should you get a loan from them, be diligent about paying them back. Come up with an agreement (in writing) between you and the family members who have loaned you money. Write down the terms of the loan, including the length of the loan, payment amounts, payment dates, and the interest rate you agree on.

Or, consider this idea, which causes less of a financial burden on your family. When holidays or your birthday rolls around, ask for loan repayment money for gifts. Let friends and family know that instead of wanting typical gifts, you’d like funds that go toward paying down your loans. This will help you get there quicker without putting any sort of strain on your relationship with loved ones.

2. Should I use a home equity loan to refinance my student loans?

The Consumer Finance Protection Bureau writes that this is a risk. This may seem appealing, particularly given today’s low interest rates, but it could have significant long-term effects. Your interest rates may be lower, but you’ve now put your home at risk. There’s a reason lenders are much more willing to offer lower interest rates — they’re aware that if you can’t pay, they have a legal claim on your home.

You are also giving up the few protection policies that are in place with your student loans. When you pay off a federal student loan using a home equity loan, you are giving up repayment options and forgiveness benefits, such as income-based repayment. Make sure you’re aware of all of the protection policies you’re giving up before moving forward with this. Who knows? Maybe there’s a policy that you can take advantage of that will help you handle your student debt.

This decision could impact your taxes, as well. This is something worth discussing with a tax adviser. The interest you’re paying on your home equity loan could mean a greater tax benefit for you when compared to the student loan interest tax deductions. This is particularly applicable for those who have a high income and itemize deductions.

The bottom line? If you have a lot of savings to fall back on, a solid job, and a clear understanding of the risks and benefits, a home equity loan could allow you to pay off your student loans at a lower interest rate. Just be aware of the consequences: If you don’t make your payments, you could lose your home.

3. Should I use a personal loan?

The appeal here is that if you can get a personal loan that has a lower interest rate, you’re then responsible for the lower rate, as opposed to being stuck with the higher student loan rate. Brian Frederick, a principal at Stillwater Financial Partners, doesn’t recommend this option, explaining that often, most personal loans have interest rates that are fairly high — dependent, in part, on your credit score and the size and length of the loan.

“The only to get a better interest rate than your student loans would be to get a margin loan and even then the rate will vary widely between brokers (you don’t get margin loans from a bank) and will be at a variable interest rate which means that you could wind up paying more in interest on the margin loan. Additionally, on a margin loan, you’re only able to borrow 50 percent of the money you put up for margin, in this case you could borrow $31,000 against the $62,000 portfolio,” he writes. There’s some risk with a margin loan, too. If the value of the portfolio falls far enough you will be subject to a ‘margin call,’ meaning you’ll have to come up with more cash to keep the portfolio from being liquidated.

However, this is assuming you can’t get a lower interest rate on a personal loan. Guy Baker, a managing director with Wealth Teams Solutions, writes that getting a lower interest rate on a personal loan is a good approach to take when it comes to dealing with student debt. Spend some time researching this one. Determine if it’s possible to get a lower interest rate, and perhaps even take the time to consult with someone to determine if this is in your best interest.

4. Should I borrow from my 401(k)?

Tread carefully with this one. This may seem like an easy option, but it also has its fair share of risks. First, the positives: Borrowing against your 401(k) is convenient. Nolo writes that since it’s your money, borrowing from your 401(k) is usually simpler than getting a loan elsewhere. Often, arranging a 401(k) loan requires you to call your firm or 401(k) provider or submit a short application. It also typically has better interest rates. The interest rate depends on the terms of your plan but is typically lower compared to most loans, meaning that if you need to pay off a high-interest debt, borrowing against your 401(k) allows you to do that and save money.

Here’s why borrowing against your 401(k) may not be in your best interest: First, consider opportunity cost. The money in your 401(k) is often invested in various stocks, bonds, and mutual funds. When you borrow from your 401(k), you’re no longer receiving a return on your investments, according to Nolo. If the market is doing well, you’re missing out on potentially big returns.

What happens if you need to switch jobs or get laid off? Should you leave your job for any reason, you usually have a short time period, around 60 days, to pay back your 401(k) loan in full. If you don’t, the loan amount will be treated as a 401(k) distribution and considered taxable income. You can also anticipate getting hit with early withdrawal penalties. Since it’s impossible to predict if a layoff is in your future, this poses as a real risk.

In some cases, you won’t be able to contribute to your 401(k) until your loan is paid off. This depends on the 401(k) plan that you have, but if you’re prohibited from contributing funds until it’s paid off, your retirement savings won’t be growing while you’re paying back the loan. Remember that saving for retirement is your top priority always. Don’t do anything that puts your retirement in jeopardy.