Ask an expert: Using home equity to pay off debt

A: A home equity loan works much like a first mortgage -- the money you borrow is secured using your house as collateral. Just as you can sell a house even if you’re carrying a mortgage, you can also sell if you have a home equity loan or line of credit. However, you’ll have to pay off the outstanding balance in full when you close the deal.

If you’re thinking about getting a home equity loan to consolidate debt, you’re usually better off staying in your house for at least a couple of years. That’s because, although home equity loans offer lower interest rates than many other loans, they usually have higher closing costs. In addition, home equity loans -- like some mortgages -- may carry a prepayment penalty, which is an additional fee for getting out before a specified term. These additional costs may exceed the savings you’d get from the home equity loan’s lower interest rate.

For greater flexibility, you may want to consider a home equity line of credit instead. Home equity lines of credit generally have lower closing fees, or none at all, and there are no prepayment penalties, since lines of credit do not have a set term. If you sell your home with an outstanding balance on the credit line, however, you’ll still have to pay it off on closing. And if you’re consolidating debt, remember that a line of credit may also offer greater temptation to go further into debt.

Finally, if your mortgage is coming up for renewal soon, consider cash-out refinancing. This involves getting a new mortgage with a higher principal than your current one. For example, let’s say you have a $250,000 home with $120,000 left on the mortgage, as well as $40,000 in credit card debt. You may be able to obtain a new mortgage for $160,000. You can then use the extra money to pay off your card balances. You’ll have the convenience of a single monthly payment, lower interest charges, and if you decide to sell your home, you’ll only have to settle one loan rather than two.

Dan Moore
Vice President, Product Management

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