When it comes to paying off student debt, it pays to get creative. From forgiveness programs, to employer student loan repayment, to student loan refinancing, there are many ways to reduce the overall cost of student loan repayment.
But would it be more beneficial to pay off your student loans using a personal line of credit instead of refinancing a student loan? That would definitely be an “out of the box” step. However, some borrowers may feel that it can save them money while also providing a higher level of payment flexibility.
When it comes to a personal line of credit versus student loan refinancing, which is better? This article explains why private student loans generally outperform a personal line of credit for lowering your student loan interest rate.
What is a personal line of credit?
A personal line of credit is considered revolving credit. It is a type of debt much like a credit card or home equity line of credit (HELOC). When borrowers get a personal line of credit, they can borrow up to a set maximum (for example, $30,000). Borrowers pay interest only on the amount they withdraw against the line of credit. You can usually use a personal line of credit to pay for anything you want.
For example, a borrower who uses $10,000 on a line of credit will only pay interest on the $10,000 borrowed. They won’t pay interest on the full $30,000 credit limit. When borrowers pay off the credit line, the remaining credit limit goes up again.
Interest rates on personal lines of credit are similar to those on personal loans. Some people will qualify for premium rates. But most of the time interest rates will be in the double digits. Often times, the interest rate on a personal line of credit is variable. This means that the price can change based on fluctuations in the market.
What is student loan refinancing?
Student loan refinancing involves taking out a private student loan to pay off another student loan. A private student loan is still an educational loan and is usually an installment loan.
With installment loans, borrowers who make payments as agreed upon will repay their student loans in a set period of time. The monthly payment and interest rate on the loan are often fixed for the life of the loan.
Personal Line of Credit Vs. Student loan refinancing
Both a personal line of credit and a private student loan are private debt. Both are used to pay for education. However, the loan options have distinct differences related to usages, repayments, taxes, credit scores, and bankruptcy.
Uses
A personal line of credit can be used for almost anything. You may be able to use the line of credit to pay for upgrades to your home, pay off credit card debt, and perhaps pay off some or all of your student loans.
However, the bank may not allow borrowers to use it to repay student loans. Restrictions on uses vary from bank to bank.
For example, Student Choice offers a personal line of credit for education as an alternative to regular student loans.
In contrast, private student loans can do this only Use them to pay off existing student loans. You can’t roll other debts into a student loan refinance.
Payment
Private student loans are often installment loans with fixed interest rates. This means that your loan repayments will be in the same month and month for a specified period of time. After that time, your loan will be repaid.
In contrast, a personal line of credit is a form of revolving credit. The interest rate is likely to change over time. The minimum payment may not result in repayment during the initial lending phase. Borrowers hoping to eliminate student loan debt should consider paying more than the minimum to reduce interest costs.
Tax implications
As you compare a personal line of credit versus refinancing a student loan, you’ll need to consider which type of debt will save you the most money on your tax bill.
Student loan borrowers are eligible for a student loan interest deduction of up to $2,500 per year. This tax advantage is a great way to save up to a few hundred dollars each year. However, interest is only limited to eligible student loans.
Eligible student loans These are loans that are used exclusively to pay educational expenses. Loans must be:
- For the taxpayer or spouse or dependent who is a student.
- For education provided during the academic period when the student was eligible.
- Educational expenses must be paid within a reasonable period of time before or after you get the loan.
Private student loans always meet this requirement. Student loans are issued only to cover the cost of attendance associated with the time an eligible student spends in school.
In theory, a personal line of credit can be considered an education loan. However, the borrower may have difficulty proving that these three qualifications are met at the time of borrowing.
And if you’re using your personal line of credit to pay for other expenses, it definitely doesn’t qualify.
Implications for credit score
When you run a personal line of credit, you increase your credit utilization ratio. And just like setting up a credit card bill, this can hurt your credit score.
In general, you want to keep credit utilization low on all of your revolving lines of credit. Fortunately, your credit score will only increase when you push down the credit limit.
By contrast, student loans are installment loans. As long as you repay your loans as agreed, the impact on your credit score will be neutral or positive.
Effects of bankruptcy
Technically, student loans are dischargeable in bankruptcy. But the borrower must prove that he or she is facing an undue hardship, which can be difficult (But it’s not impossible) to prove in court.
In contrast, a personal line of credit can often be discharged in bankruptcy. However, a bankruptcy judge may require the borrower to repay the line of credit if it is considered an education loan. This means that you should not try to refinance your loan at the last second before filing for bankruptcy in an attempt to pay off your loans.
What type of financing should you choose?
In general, borrowers should avoid using a personal line of credit to repay student loans. While it may provide a small opportunity for interest rate arbitrage, the tax and credit implications will likely outweigh the benefits.
So does this make refinancing student loans the right choice for most people? Not so fast. While this article assumes that the borrower wants to refinance, this may not actually be the best option for federal student loan borrowers. When you refinance federal student loans, you lose access to things like income-driven repayment (IDR) plans, forgiveness programs, and other federal benefits.
If you have federal student loans, you’ll need to be careful when considering any refinancing strategy. Learn how to decide if student loan refinancing is right for you.
