Home Equity Loan for Debt Consolidation: Should You Do It?
Paying off debt is a common but often challenging goal, especially when interest rates are high and money is tight. As a homeowner, a potential solution is to use a home equity loan for debt consolidation, which involves tapping a portion of your available equity to pay off some or all of your debts.
It can seem like a quick fix to use a home equity loan to pay off debt, but it’s important to weigh the potential benefits against the risks.
- Borrowing against your home equity to consolidate debt can be worthwhile if it helps you save on interest charges or lower your monthly payments.
- Home equity loans typically have lower interest rates than personal loans and other lending products.
- You could lose your home to foreclosure if you default on your home equity loan payments.
Should you get a home equity loan for debt consolidation?
Using a home equity loan to consolidate debt can be a good option if you’re struggling to manage your monthly debt payments and have sufficient equity in your home. Home equity loans allow you to convert some of your home’s equity to cash that you’ll receive in a lump sum and must repay over a certain number of years. They’re a type of second mortgage.
A home equity loan is often helpful if you have high-interest debt, such as credit card debt, since you can secure a lower interest rate and save money in the long run.
You could use a home equity loan to pay off various debts, including:
- Credit cards
- Personal loans
- Student loans
- Medical bills
It’s generally not recommended to use home equity loans to pay off a loan tied to a depreciating asset, such as a car or boat. Additionally, it may be better to pay off low-interest debt by adjusting your budget and making a higher minimum payment.
Pros and cons of using a home equity loan to pay off debt
Pros
- You’ll simplify your monthly payments: Instead of having multiple due dates to keep track of each month, you’ll only have one. This can help you avoid missing payments on your credit cards or other debts, which is crucial if you want to maintain a good credit score.
- You might get a lower interest rate: Since home equity loans are secured by your home, lenders consider them lower risk and therefore typically offer lower interest rates.
- You could end up with lower debt payments: Consolidating debts using your home equity may reduce your monthly payments, since it’s likely the home equity loan will have a lower interest rate.
Cons
- You may have to pay fees: Taking out a home equity loan comes with various closing costs, which may include a loan origination fee, appraisal fee and credit report fee. These fees could end up costing between 2% and 5% of the loan amount.
- Your home is at risk of foreclosure: Your home is used as collateral on a home equity loan — this means that if you fail to make payments, your lender can repossess your home through the foreclosure process.
- You could end up underwater on the loan: When you take out a home equity loan, your equity shrinks. If, for some reason, your home value drops, it’s possible you could end up owing more on the home than it’s worth.
Are you eligible for a home equity loan?
Lenders assess several key factors to determine your home equity loan eligibility, including:
Home equity
You’ll generally need at least 15% equity in your home to qualify for a home equity loan to consolidate debt. However, this will vary slightly between lenders.
Credit score
Again, this will vary from lender to lender. Most lenders set a 620 minimum credit score for home equity loans. If your score is on the lower end, you can expect a higher interest rate.
Don’t know your credit score? Get your free score on LendingTree Spring today.
Debt-to-income ratio
Home equity loan lenders typically require you to have a maximum 43% debt-to-income (DTI) ratio. This means that no more than 43% of your gross monthly income goes toward your monthly debt obligations.
Compare home equity loan rates from top lenders in minutes
How to apply for a home equity loan to consolidate debt
1. Calculate your home equity
You’ll want to find out how much home equity you have to determine whether getting a home equity loan is worth it and if you’d qualify. To calculate your home equity, simply subtract your existing mortgage balance from your home’s value. You can typically borrow up to 85% of your home’s value, though some lenders may let you borrow up to 90%.
Estimate how much you could borrow with our home equity loan and HELOC calculator.
2. Shop around for lenders
Since rates, fees and eligibility requirements can vary significantly between lenders, it’s wise to compare a few different options before making a decision. Doing so can help you find the best deal for your needs.
3. Receive the funds
Once you choose a home equity loan lender, get approved and pay the closing costs, you’ll receive the loan proceeds in a lump sum. You can then use the funds to pay off your existing debts.
Alternatives to using home equity for debt consolidation
Home equity line of credit (HELOC)
A HELOC, like a home equity loan, is a type of second mortgage. Instead of receiving a lump sum, a HELOC provides a revolving credit line that works similarly to a credit card. You can use a HELOC to pay off debt by withdrawing from the credit line, repaying it and withdrawing from it again as needed — but only during the draw period, which is typically 10 years. You may only have to make interest payments during the draw period. However, once the draw period ends, you’re required to make both principal and interest payments over a set repayment term.
Compare current HELOC rates.
Personal loan
Personal loans are typically unsecured, which means they don’t require collateral like home equity loans and HELOCs do. This is a big plus if you’re not comfortable putting your home on the line to pay off your other debts. However, because there’s no collateral, lenders will charge you a higher interest rate to account for the higher risk.
Borrowers with good credit scores may qualify for a personal loan that has a lower interest rate than their current debts, such as credit cards, but the rate will likely still be higher than the rate for a home equity loan.
Estimate your monthly payments using our personal loan calculator.
Balance transfer credit card
If you have strong credit, you may be eligible to transfer your balance from a high-interest credit card to one with an introductory 0% annual percentage rate (APR) for a set time. Some credit cards will allow you to transfer a balance with no fees and make payments without interest for up to a year or longer, which can buy you time to pay off credit card debt, minus extra fees.
Cash-out refinance
Another way to borrow money against your home equity is to pay off your first mortgage and take out cash at the same time using a cash-out refinance. This will replace your existing mortgage with a new loan that has new terms — and give you a cash lump sum to pay off your debt.
Just keep in mind you’ll need at least 20% equity and a 620 credit score to meet qualification requirements — and a 780 score or higher if you want to get the best interest rates available. If you need a low-credit option, you can look into an FHA cash-out refinance backed by the Federal Housing Administration, though you’ll have additional costs in the form of FHA mortgage insurance.
Frequently asked questions
Not having enough equity in your home, having a low credit score or having too much debt compared to your income are all factors that could disqualify you from getting a home equity loan.
Having a home equity loan generally won’t hurt your credit, as long as you don’t miss any payments. However, your credit score may take a slight hit when you first get the loan, since the lender will run a credit check to assess your eligibility. This is known as a “hard inquiry,” and it’s one of the five credit factors that affect your score.
To find out how much your monthly payment would be if you took out a $100,000 home equity loan, you’ll need to know the loan term and interest rate. For example, a 20-year loan at a 6% interest rate would cost about $716 a month.
If you want to keep your home equity intact, other options to get out of debt include:
- Debt avalanche or snowball method: These debt pay-off strategies involve paying off your debts in order from smallest to largest balance, or from highest to lowest interest rate.
- Debt management plan (DMP): A DMP involves working with a credit counseling agency to negotiate with your creditors to lower your interest rates or monthly debt payments.
- Bankruptcy: If you’re facing serious financial hardship and don’t think you’ll ever be able to repay your debt, bankruptcy might be worth considering. Consult with a lawyer to understand whether you’ll be able to keep your home after filing for bankruptcy.
Compare Home Equity Offers
Read more
Can You Get a Home Equity Loan With Bad Credit? Updated August 21, 2024 To get a home equity loan with bad credit you’ll need more income, more home…Read more
How To Refinance a HELOC Updated August 2, 2024 If you find that payments on your home equity line of credit (HELOC) stress your…Read more