Bottom line: you should only use your home equity to consolidate debt if you have sufficient equity, if you can qualify for a lower interest rate than your current debts, and if you have absolute confidence that you can repay the loan.
Home Equity Loans and Debt Consolidation at a Glance
Home equity loans can be used to combine multiple loans into a single debt with one monthly payment, simplifying your finances, lowering your monthly payments, and ideally saving you some money.
The downsides of home equity loans include using your home as collateral, fees and other loan expenses, and reducing the ownership stake in your home.
To find the right home equity loan, make sure to shop around with multiple lenders and compare rates – but make sure to look at alternatives.
What Is Home Equity — and How Is it Used to Consolidate Debt?
Home equity is the difference between your mortgage balance and the current value of your home – essentially, the amount of your home that you own free and clear. You can borrow against your home equity for all kinds of reasons, including using a debt consolidation loan, using one of two methods:
A home equity loan acts as a second loan on your home, with its own fixed interest rate, monthly payment, and repayment term. You receive one lump sum all at once.
A home equity line of credit (HELOC) acts as a line of credit that you can borrow from, up to the limit, similar to a credit card. You draw from your credit line as needed during the draw period, then pay your balance back over time. HELOCs have variable interest rates.
To consolidate your debts, you take the provided funds and use them to pay off your existing debts. Then, you make one monthly payment to the lender over time until the debt is completely paid off.
Pros of Using Home Equity to Consolidate Debt
There are several advantages to using home equity in order to consolidate debt:
Lower interest rates
“A potential advantage of using your home equity to consolidate debt is that home equity loans and HELOCs may have lower interest rates than other forms of debt, such as credit cards or personal loans,” says Drew Feutz, certified financial planner and founder of Migration Wealth Management, LLC. This can save you money in the long run.
Simplified payments
When you consolidate several debts using your home equity, you are trading multiple payments for a single payment with one due date. This can make it easier to keep track of your debts and plan for your monthly payments.
Lower monthly payments
If your home equity loan or HELOC has a lower interest rate than the debts you’re consolidating or your loan repayment term is long enough, you could see lower monthly payments. You can free up room in your budget and put that money toward other financial goals, or even use the savings to pay your loan off faster.
Cons of Using Home Equity to Consolidate Debt
There are also some disadvantages to using home equity for debt consolidation:
Home as collateral
“A potential disadvantage of using your home equity to consolidate debt is that your home serves as collateral and you may end up consolidating previously uncollateralized debt into a loan that is collateralized by your home. If you fail to pay back a home equity loan or HELOC, you risk foreclosure and losing your home,” says Feutz.
Fees
“Fees/costs associated with home equity loans will differ depending on the lender, but generally include origination fees for processing the loan, appraisal fees to determine the value of your home, closing costs for a title search and to record the loan, and potentially an ongoing annual fee for HELOCs,” says Feutz.
Reduced ownership stake
When you trade in some of your home’s equity for a loan or HELOC, you reduce your ownership stake in your home, and you will have to pay back that debt in order to reclaim your equity. And if property values drop, you could end up with very little equity or even owe more than your home’s value, which can make it difficult to sell your home or refinance your mortgage.
And don’t forget, if you sell your home before the loan or HELOC is repaid, you will have to pay it back in full, reducing the proceeds from the home sale.
Rising interest rates or payments
HELOCs usually have adjustable interest rates, which means your payments can fluctuate and increase when interest rates rise. This means you could end up paying more than you thought when you took out a HELOC. And many HELOCs allow interest-only payments during the draw period (when you can borrow your funds) – but minimum payments will increase after the draw period closes and you start paying the principal.
Types of Debt to Consider Consolidating With Home Equity
Some types of debt are better to consolidate than others:
Credit cards
Top credit card providers tend to offer higher interest rates than home equity loans and HELOCs. You can pay off your credit cards all at once, then save on interest by paying back your home equity loan over time.
Personal loans
Unsecured personal loans often have higher interest rates than you can get by tapping your home equity, which makes them a good fit consolidation. A secured personal loan may or may not have a higher interest rate – but you might want to consolidate a secured loan if you want to trade one type of collateral (e.g., your vehicle or an investment account) for another (your home).
Payday loans
Payday loans and other types of high-interest debts can get you quick cash, but they come with exceedingly high costs. If you can qualify for a home equity loan or HELOC, you can likely access a much lower interest rate, making it a no-brainer to consolidate payday loans in many cases.
Types of Debt to Avoid Consolidating With Home Equity
Medical bills
Home equity loans can consolidate unpaid medical bills, which may provide you relief if you have debt collectors calling or you want to avoid damaging your credit. But you should explore other options first – many medical providers have billing departments that can work with you to arrange a repayment plan or even settle for a lower payoff amount. And you have a 365-day grace period to pay off medical bills before they land on your credit report, giving you some time to settle the debt – and medical bills under $500 won’t ever affect your credit.
Student loans
You can consolidate both federal and private student loans. But federal student loans have borrower protections in place, and even repayment programs that can reduce your monthly payment based on your income and other factors. If you consolidate your federal student loans, you lose access to those programs.
Auto loans
Since your car loan is secured by your vehicle, it won’t make sense to consolidate when the interest rate isn’t significantly different. Plus, if you failed to repay your loan, you’d probably rather lose your car than your home. Finally, the value of your car depreciates over time, while home values tend to rise.
Getting a Home Equity Loan to Consolidate Debt: Tools and Strategies
Here are some tools and strategies you can use to get a home equity loan for debt consolidation:
Know how much you need to borrow
Make a list of all your debts, including the name of the creditor, the interest rate, and monthly payment. Choose which debts it makes sense to consolidate, then add the balances together to arrive at the total amount you need. This should give you an idea if you have enough equity in your home to consolidate your debts.
Figure out your qualifications
Before you can take out a home equity loan or HELOC, you will need to apply for one and meet the lender’s requirements:
Sufficient equity. Most lenders will require you to have at least 15% to 20% of your home’s value in equity before you can secure a loan or HELOC.
Credit score. Lenders may look for a credit score of at least 680, though some lenders may accept scores as low as 620. The higher your credit score, the better the interest rate you can get.
Income. You need to have sufficient income to repay your loan, and lenders will also look at your debt-to-income ratio – if you have too much debt compared to your income, you won’t qualify.
Gather your documents
To submit an application for a home loan or HELOC, you need to provide key documents. Make sure to gather these ahead of time to make the application process smoother:
Full name, Social Security number, and date of birth
Current and previous addresses
Name of your employer and employment history
Photo identification
Recent paystubs and W-2s
Recent tax returns
Property information including proof of homeowners insurance, mortgage statements, and property tax statements
Shop around
Compare lenders and rates to look for the best deal. While you may want to start with your current mortgage lender, you don’t have to go with them. Compare rates online or work with a mortgage broker to find the right lender.
Pick the right repayment term
Home equity loans offer terms ranging from five years, 10 years, 15 years, and even longer. If you choose a shorter repayment period, your monthly payments will be higher. But shorter repayment periods often come with lower interest rates, and lower total repayment costs over the lifetime of the loan.
Debt Consolidation Alternatives to Home Equity Loans
Credit Card Balance Transfer
Looking to consolidate credit card debts? Consider a balance transfer credit card with a low introductory APR offer – some cards go as low as 0% for qualified borrowers. You can move your credit card balances over to the new card, and try to pay down your debt before the introductory interest rate expires.
Personal loan
Personal loans can be used for many financial purposes, including debt consolidation. These loans are typically unsecured (though there are personal loans you can secure with collateral like a car or bank account), which means lower risk for you. On the flipside, you might pay higher interest rates than you would with a home equity loan or HELOC.
401(k) loan
If your plan administrator allows it, you can borrow money from your 401(k) to consolidate debt and pay yourself back over time. But this can severely reduce the savings potential for your retirement accounts, and you may have to pay back the loan in full all at once if you leave your job.
Frequently Asked Questions
Can I Get a Home Equity Loan to Pay Off Debt?
You can use a home equity loan or HELOC to pay off debt, then repay the new lender. This essentially transfers your old debts to a new lender, ideally with a lower interest rate and/or better repayment terms.
Is It a Good Idea to Use Home Equity to Consolidate Debt?
It may be a good idea to use home equity to consolidate debt if you have substantial equity in your home, have a stable income, and can access a much better interest rate through a home equity loan or HELOC than you’re paying on your current debts.
What Is the Best Option to Consolidate Debt?
The best option to consolidate debt depends on many factors including the amount of your debt, the types of debt you have, the interest rates you are paying, your credit score, and other factors.
