Why Student Loans and Mortgages Don't Mix

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Last week, I heard a terrible story about a friend of a friend. Specifically, the friend's friend was planning to roll a six-figure student loan debt into their mortgage.

I've never met this person, so I can't hurl myself upon them shouting, "Stop! Stop before it's too late!" So consider this post the digital equivalent. You should never, ever roll your student loan debt into your home -- particularly not if your home was purchased at extremely low cost 10 years ago, and your student loan debt is about the size of the principal on your mortgage.

I know what you are about to say. I've heard all the excuses. "I'll only have one payment to make every month!," people tell me. "And at such a low interest rate! I'll save hundreds of dollars a month! It's a great deal!"

Actually, you're not saving hundreds of dollars a month, because most of these "deals" involve stretching your loan repayment out to 30 years. Over the lifetime of the loan, even at today's low interest rates, you're going to end up paying more interest, not less. More importantly, refinancing your house to pay off your student loan debt violates one of the cardinal principles of personal finance, which is that you should never, ever use home equity to pay off other debt unless some debt collector is getting ready to go to court to sue and take your house. At which point, you probably can't qualify for a mortgage anyway, so that's a theoretical case of little practical interest. In the real world, you should follow this simple rule: Don't refinance the house to pay off debt.

"Why not?," you ask. "The interest rates are so much lower!" Why yes, they are. And do you know why they offer such attractive low interest rates? Because if you don't pay the debt, they can come and take your house. Now you're broke and you have nowhere to live.

Home equity is one of the few assets protected in bankruptcy. Unless you live in one of those states that basically allows creditors to seize and sell any house with more than a tiny smidgen of equity (I'm looking at you, Alabama), you should never tap your home equity to pay off other debt, because you're essentially using a protected asset that could function as savings if you go broke and need bankruptcy protection. This is also why you should never tap a retirement account to pay off old debts, unless you are a) retired and b) able to easily spare the money.

Of course, student loans aren't bankruptable. But while student loans have more collection options than most loans (they'll grab your tax refund without going to court), they can't kick you out of your house six months after you miss a payment. Your mortgage lender can. Essentially, the reason that the interest rate on mortgages is so low is that the lender is "paying" you to take on extra risk -- the risk of losing your house when you can least afford it.

The way to pay off onerous debt is to ... pay it off. Make extra payments every month. Pay off the smallest debt first, then apply that payment to the next biggest. This is tedious and involves sacrificing present consumption. It's much less fun than trying to surf interest rates with balance transfers. But there's much less chance that you'll get swamped by an errant wave.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net