Is A Home Equity Loan For Debt Consolidation Right For You?

Struggling to stay on top of various debts? You’re far from alone: Debt can grow quickly, and it can become overwhelming just as fast.

But if you own a home, you might be able to tap its equity in the form of a home equity loan. You can then use the funds from this loan to consolidate your debt, replacing several monthly payments with just one payment at one (hopefully) lower interest rate. It’s a way to gain control over your debts.

Be careful, though: Using the equity in your home for debt consolidation isn’t risk-free. If you don’t make your home equity loan payments on time, you could lose your home.

How A Home Equity Loan For Debt Consolidation Works

What is home equity? It’s the difference between what you owe on your mortgage and what your home is worth. Say you owe $150,000 on your mortgage and your home is worth $350,000. You have $200,000 in equity.

Depending on your financial situation, you could borrow against up to 90% of that equity in the form of a home equity loan. For example, if you have that $200,000 in equity, your lender might approve you for a loan of $180,000. You’d receive those funds in a single payment and then pay back what you borrowed – plus interest – In regular monthly payments.

A home equity loan is a second mortgage. Once you take one out, you’ll make two mortgage payments each month – one to your original mortgage and one to your home equity loan.

You can use the funds from a home equity loan for whatever you want. This includes consolidating existing credit card, medical or other forms of debt. Essentially, you’d be swapping your existing debt with your home equity loan debt.

Why do this? Home equity loans typically come with lower interest rates than what you’d get with credit card, personal loan and other forms of debt. This means that you’ll pay less each month to pay back your home equity loan than you would by paying off credit card debt on your own.

Say you have $20,000 worth of credit card debt at 20% interest and a personal loan balance of $10,000 at 12% interest. You might consolidate those debts with a home equity loan that comes with a far lower interest rate of 7%. You’d potentially save thousands of dollars in interest payments with this move.

You can also replace several monthly payments with just one home equity loan payment. That can make keeping track of your payments an easier task.

The Pros And Cons Of A Home Equity Loan To Consolidate Debt

As with all forms of debt consolidation, there are both positives and negatives with using a home equity loan to pay off existing debt. Here are the most common.

Types Of Debt That Home Equity Loans Can Consolidate

You can use the funds from a home equity loan for whatever you’d like, including consolidating most of the debts that you face.

Medical Debt

Even with health insurance, medical bills can pile up. Do you owe medical debt following a hospital stay, in-patient surgery or expensive treatment? You can use the funds from a home equity loan to consolidate this debt. Instead of making several payments each month to different doctors or hospitals, you can make a single payment to the lender behind your home equity loan, hopefully at a lower interest rate.

Personal Loan Debt

Personal loans tend to come with higher interest rates than do home equity loans. The Federal Reserve Board said that the average interest rate on a 24-month personal loan was 12.35% as of November of last year. If you can qualify for a home equity loan with an interest rate closer to 7%, it might make sense to use the funds from one of these loans to consolidate your higher-rate personal loan debt.

Credit Card Debt

Credit card debt comes with notoriously high interest rates, with the Federal Reserve Board saying that the average interest rate on credit cards stood at 21.47% as of November of 2023. Depending on how much you owe, you could save thousands of dollars in interest by using a home equity loan to pay off your credit cards. Because of the high interest rates that come with it, this might be the best debt to consolidate with a home equity loan.

Student Loan Debt

In information last updated in May of last year, the Education Data Initiative said that the average amount of federal student loan debt that borrowers carried was $37,338. Private student loan debt averaged $54,921 a borrower. If you are struggling with student loan debt, using the funds from a home equity loan could help. Just make sure that the interest rate on your home equity loan is lower than the rates on your student loans, otherwise consolidating this debt won’t make financial sense.

4 Alternative Options To Consolidate Debt

Maybe a home equity loan isn’t the right choice for you. Fortunately, there are other ways to consolidate your debt. Here are some options.

1. Cash-Out Refinance

In a cash-out refinance, you refinance your existing mortgage for more than what you owe. You can then use the extra cash however you’d like, including using it to consolidate higher-interest-rate credit card debt and other forms of debt.

Say you owe $200,000 on your mortgage. You can refinance to a new loan of $250,000. You’d then receive the extra $50,000 in a single payment. You can use that money to put toward consolidating your other debts. Just remember, doing this will reduce the equity in your home and you will have to pay back all of what you borrowed, with interest.

2. HELOC

You can also use the equity in your home through a home equity line of credit (HELOC). A HELOC acts a bit like a credit card, with your credit limit determined by the equity in your home. Say you have $100,000 of equity. You might qualify for a HELOC of $80,000. You don’t receive the $80,000 as a single payment like when you take out a home equity loan. Instead, you can borrow from an $80,000 line of credit anytime during your draw period.

Maybe you have $35,000 in credit card debt. You can borrow that $35,000 from your HELOC to consolidate that debt. With a HELOC, you only pay back what you borrow. If you borrowed only that $35,000, that’s all you’d pay back once your HELOC enters its repayment phase.

3. Personal Loan

You can apply for an unsecured personal loan from lenders both in person and online. As with a home equity loan, you’ll receive your loan amount in one lump payment that you can spend however you’d like. The goal, again, is to end up with a personal loan that has a lower interest rate than the debt you’re consolidating.

Because personal loans are unsecured, you won’t put your home at risk. If you stop making your monthly payments, your lender can’t foreclose on your home. On the negative side, personal loans typically come with higher interest rates than do home equity loans. Depending on your credit, you might not be able to borrow enough to consolidate all your other debts.

4. Balance Transfer Credit Card

Some credit cards offer balance transfer options that can help you consolidate and pay off existing credit card debt. When you apply for a new credit card, it might give you the option to transfer the money you owe on other credit cards to your new card at 0% interest. This debt carries that 0% interest for a limited time, usually 12 – 15 months. You can then work on paying off your credit card debt without having to worry about it growing because of high interest. The key is to pay off the debt before the 0% offer ends. It’s also important to not rack up additional debt that you can’t pay off in full each month on your new card.

The Bottom Line

If you’re ready to consolidate your existing debt, a home equity loan could help. The key is to make sure that your new loan comes with an interest rate low enough to make consolidating your debt a smart move. It’s also important to make sure you can afford your new home equity loan payments. If you fall behind on those, you could lose your home.

And if you want to gain more control over your finances, download the Rocket Money℠ app to track your spending, set a budget and monitor your credit score.