Using Home Equity Loan for Debt Consolidation

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September 12, 2023

Using Home Equity Loan for Debt Consolidation

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Recent headlines confirm Americans are racking up more in credit card debt than in recent years. And honestly, it’s not too surprising given the economic struggles most of us have faced. But perhaps you’ve hit a limit with the amount of credit card debt you have, and you’re ready to get your monthly payments under control.

When you’re faced with multiple monthly debt payments for credit cards, medical bills, personal loans, or other unsecured debt, many turn to debt consolidation—specifically, using a home equity loan to pay off what you owe. So, let’s discuss when this may or may not be a wise financial move.

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What is a home equity loan?

A home equity loan means borrowing money against the equity you’ve built up with your home. It’s a secured loan, which means the loan’s guaranteed with an asset. In this case, the asset used is your home. So, if you default on the home equity loan, the financial institution goes through the foreclosure process with your property to recoup its money.

Similarly, a homeowner may consider using a home equity line of credit or HELOC. In this case, the financial institution offers you a predetermined credit limit, which you borrow against as needed. As you pay down the balance, your borrowing limit gets restored to the original credit limit amount. Like a home equity loan, your home acts as collateral, which means you can also face foreclosure for defaulting on a HELOC.

Both home equity loans and HELOCs can be used for debt consolidation.

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What is debt consolidation?

Debt consolidation involves taking out a new loan (in this case, a home equity loan) and using the funds from the new loan to pay off unsecured debt — or debt that isn’t guaranteed by an asset. Common examples of unsecured debt include credit cards, personal lines of credit, personal loans, and medical debt.

One note is that debt consolidation is not the same as debt settlement. Debt settlement is when you or a third-party company negotiate to lower your debt and make payments with a new, agreed-upon schedule.

With debt consolidation, there’s no change to the amount you owe, but rather you pay off each balance with the funding you receive from the home equity loan.

Related: Best Home Equity Loans

Pros and cons of using a home equity loan for debt consolidation

There are multiple reasons why a homeowner might choose a home equity loan or HELOC as part of a debt consolidation strategy.

Pros

Streamlined monthly payments. One of the most common reasons debt consolidation is so attractive is that you can simplify your finances with a singular payment versus multiple. When juggling multiple payments each month, it takes quite the mental energy to keep up with each one, not to mention it wreaks havoc on your budget, balancing the minimum payments or more.
Potential lower interest rate. Interest rates are a hot topic right now. We have witnessed mortgage rates double compared to a few years ago, and our credit card and personal loan rates have also increased. Home equity loan interest rates vary, but currently, you can find rates anywhere from 6.88% to 13%, depending on your creditworthiness and the lender. But if you can lock in a lower interest rate with a home equity loan versus the higher interest rates with your credit cards or personal loans, you can save money each month on interest charges alone. Not only does it lower your monthly payment when you lower your interest rate, but you pay less for a loan over the entire loan term when you have a decreased interest rate.
Lower monthly payment. Depending on your loan term, such as a seven-year or ten-year option, it could mean a lower monthly payment — even with a lower interest rate. This can loosen up your monthly budget and give you more breathing room.

Cons

Your home is on the line. When you use a home equity loan, you pledge your home as the guarantee for the loan. You lose your home if you get behind on your monthly payments and default on the loan. It’s a riskier financial move, and you should only proceed if you know you’re disciplined enough to stay on top of the payment and not take on too much other debt.
Diluting your home ownership. When you take on a home equity loan and borrow against your equity, you’re giving more ownership to another financial institution, and less equity, or ownership, is available. It also means if you end up selling your home for any reason, the proceeds from the sale of your home automatically pay off your first mortgage and your home equity loan.
Additional fees. Taking out another loan isn’t always the least expensive option. Numerous fees are associated with home equity loans, which can chip away at any potential upside to your finances. For example, the lender may charge an application fee, loan origination fee, credit report fee, or home appraisal fee. The lender may charge closing costs, too. Make sure you’re aware and budget for these fees so you know the true cost of the home equity loan. Once you have the true cost, you can calculate if it’s worth taking out the loan for debt consolidation purposes.

Home equity loan for debt consolidation right for me?

Your financial situation is unique to you, so the answer depends on your personal circumstances. A home equity loan may be worth considering if:

You have a large debt: If you can’t reasonably pay off the debts you owe within a year without some financial relief.
You’ve considered other alternatives: If you have a smaller debt, could a balance transfer credit card with an introductory 0 percent interest rate work?
You have a good or excellent credit score: This means you can qualify for more competitive interest rates for a home equity loan and pay less overall through the life of the loan.
You understand what caused your debt: You’ve either made changes to your financial behavior or recognized why you’re in debt. The best action is not adding more credit card debt than taking on a home equity loan.

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Powerful home equity solutions
Get transparent rates from providers
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Connect with lenders for $0
100% online experience

Compare mortgage offers from major lenders

FAQs

How do you get a home equity loan?

You can apply for a home equity loan with any bank, credit union, or online lender, and the lender doesn’t have to be the same as your original mortgage. Most offer online applications; you can apply over the phone or in person.

Does debt consolidation hurt your credit?

Initially, there may be a negative impact on your credit score due to the hard inquiry from the lender. However, on-time payments and an improved credit mix may eventually increase your credit score.

How do I qualify for a home equity loan?

Lenders often have minimum credit score requirements for home equity loans, typically in the good or excellent credit score range. They also review your income and verify you have enough funds each month to cover your monthly payment and other outstanding debts – this is your debt-to-income ratio, and lenders prefer a lower number. Lenders also use a loan-to-value ratio or LTV. LTV is the combined balance of your primary mortgage and home equity loan compared to your home's value. Lenders typically prefer an LTV of 80% to 90% of your home’s value, which means you have to keep some equity in your home.

The bottom line

In some circumstances, using a home equity loan for debt consolidation makes financial sense, but it’s not necessarily for everyone. You’re simplifying your monthly payment schedule and can save money in the long run on interest charges. However, you’re taking on secured debt guaranteed by your home, which means you risk losing your property if you default on your home equity loan for some reason. After careful consideration, you should proceed with a debt consolidation plan, such as using a home equity loan.

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Sara Coleman is a former corporate gal turned creative entrepreneur. She began writing professionally several years ago and now contributes to multiple websites, blogs, and magazines. She’s also an avid reader and can’t resist a great historical fiction novel. Sara holds a BA in journalism from the University of Georgia and can be found supporting her Bulldogs every chance she has. She resides in Charlotte, North Carolina, with her wonderfully supportive husband and three children. When she’s not ushering her kids to sports and dance lessons, she can be found creating content for her own website, TheProperPen.com.

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