Should you use a home equity loan to pay off your debts?

If you’ve been watching the size of your credit card bills grow recently, you’re not alone. One-half (50 percent) of credit cardholders carry a credit card balance from month to month, according to Bankrate’s Credit Card Debt Survey. And of those who do carry a balance, the majority have been lugging it around for at least the past 12 months: 60 percent of those credit cardholders have been in credit card debt for at least a year. Even worse, a lot of them don’t have a strategy to get those balances off their backs: Only 42 percent of Americans with credit card debt have a plan to pay off that credit card debt.

If you’re a homeowner struggling with ballooning balances, a home equity loan can be an effective solution. The average interest rate on home equity loans — and HELOCs, their line-of-credit cousins — is much lower than the rate attached to credit cards and unsecured personal loans. It’s currently under 9 percent, while average credit card rates are still north of 20 percent, according to Bankrate’s latest figures. 

This sort of financing comes with a huge risk, though: Your home could be foreclosed if you fall behind on payments. Here’s the info you need to decide if a home equity loan can provide a smoother runway to shed your high-priced debt.

Why use a home equity loan to pay off debt?

Because they have lower interest rates than other loans, using a home equity loan or a HELOC to pay off debt is a viable choice for people who own much of their property outright, free of mortgage debt. It’s on the radar for quite a few of them, too: 30 percent of homeowners agree debt consolidation is a good reason to tap home equity, according to Bankrate’s Home Equity Insights Survey.

Laura Sterling, vice-president of marketing for Georgia’s Own Credit Union, says that home equity loans are more affordable than unsecured loans. “If a consumer has a significant amount of equity in their home, has the discipline to stay within their means when it comes to borrowing, and has sound financial health, it can be a cost-effective way to pay down debt,” Sterling says. 

However, she adds, “it takes discipline and comes with risk.” If you’re consistently late repaying your home equity loan (or, worse, miss the payments altogether), you could put your home at risk of foreclosure.

Pros of using home equity to consolidate debt

Using your home equity for debt consolidation can be a smart move for a number of reasons.

One streamlined payment

When you consolidate your debt by using your home equity, you can simplify your life. Rather than paying one credit card bill on the 15th, another on the 20th and your personal loan on the 27th, you’ll just have one due date to remember every month. Since on-time payments are a critical component of your credit score, this can help eliminate the potential for missing a payment due to calendar confusion.

Lower (and locked-in) interest rate

Since your home is acting as collateral, a home equity loan generally comes with a lower interest rate than other, unsecured forms of debt that aren’t backed by anything. In October 2024, home equity loan rates are averaging under 8.5 percent – a much more attractive price point than the 20.55 percent average credit card rate.

Plus, a home equity loan carries a fixed rate, so your payment will always be the same. That’s a big difference from a credit card, which has a variable APR. (Note: Most home equity lines of credit also have fluctuating rates, though you can sometimes switch to a fixed-rate HELOC.)

Lower monthly payments

Using a home equity loan for debt consolidation will generally lower your monthly payments since you’ll likely have a lower interest rate and a longer loan term. If you have a tight monthly budget, the money you save each month could be exactly what you need to get out of debt.

Cons of using home equity to consolidate debt

While a home equity loan for debt consolidation might work for some people, it’s not necessarily the best choice for everyone.

Home’s on the line

There’s a reason that home equity loan rates are lower than a lot of other borrowing routes: The lender gets to take your house if you don’t pay it back, which offers a pretty nice piece of reassurance. The potential for foreclosure should be top of mind if you’re thinking about applying for a home equity loan. Should you sell your home while the loan is outstanding, you’ll have to repay it all at once, the same way you’d have to settle your original mortgage.

Increased debt load

While a home equity loan can consolidate your debt, it’s only helpful if you limit the spending that caused that debt to pile up in the first place. f you clear your card balances, and then promptly start charging again, you’re making your debt worse: Now you’ll owe a home equity loan payment as well as credit card payments. It’s crucial to address the root cause of your debt before taking on another loan.

Borrowers need to have a healthy amount of home equity (owning at least 20 percent of the home, and preferably closer to 40 or 50 percent), to qualify for these loans. But bear in mind that, by borrowing against your home equity, you’re essentially depleting your ownership stake. In other words, your assets have shrunk, and your obligations have increased. That’s not going to improve your debt-to-income ratio or your loan-to-value ratio, two aspects of your financial profile that lenders often look at.

Fees

You might be on the hook for closing costs — various little extra expenses imposed by the lender: an origination fee, a home appraisal fee (to verify your home’s value), a credit report fee — to name just a few. These expenses tend to be less than those for mortgages, but they do add up. If you have a lot of debt to consolidate, paying these extra fees might still make sense, but it’s wise to budget for them, and compare them to the amount you’d ultimately save in interest with the loan over the credit card bills.

What kind of debt should you consolidate using a home equity loan?

These are the types of debts that are well-suited to being paid off with home equity loans.

Credit cards

Many homeowners use a home equity loan to settle outstanding credit card balances — after home renovations, it’s the most common application. The reason is simple: home equity loan interest rates (currently averaging 8 to 9 percent) run at least half of those of credit cards (over 20 percent). That means you can pay your credit cards off with one lump sum, faster and more cheaply, than you would by just making the minimum credit card payment each month.

Personal loans

Personal loans vary a great deal, but odds are the interest rate on yours will be higher than that of a home equity loan, especially if it’s unsecured. Loans that aren’t backed by any collateral usually are pricier than secured ones, because the lender is assuming more risk. Home equity loans often offer much longer repayment terms — as much as 20 years — than personal loans do, too.

Medical bills

According to recent research from the Consumer Financial Protection Bureau, 15 million Americans have medical debts on their credit reports with an average balance greater than $3,100. You can use your home equity to cover such healthcare costs, if a substantial amount isn’t covered by health insurance. And if you opt for a HELOC, you can benefit from flexible repayment amounts (most allow for interest-only payments during their initial draw periods). Before you make any decisions with your medical debt, however, talk to the healthcare provider about the availability of low-cost payment plans.

Student loans/educational expenses

If you need to pay off student loans, borrowing money from your home is one possible way to do it — provided the home equity loan offers a lower interest rate or other more favorable terms. However, you won’t get to take advantage of the student loan tax deduction, and if it’s a federal loan, you’ll lose other potential benefits, like forgiveness or income-based repayment options. A better course might be to pay college tuition directly with a HELOC, which allows you to withdraw funds in installments, owing interest only on what you borrow.

What kind of debt should you not consolidate using a home equity loan?

There are some times when a home equity loan may not be the best idea.

Auto loans

A car is an item that depreciates, meaning that it loses value over time. That means in a few years, your home equity loan balance could be more than the value of your car. Also, auto loan rates are currently competitive with home equity loans.

Vacations/luxury items

Though tempting, it is not a good idea to use a home equity loan for a holiday or a big-ticket item. If you have to take a loan, it means that your income cannot sustain your spending and this bad habit can sink you lower into debt. Before you splurge, remember how long a loan will last; you will be still repaying it long after the good times are over.

Mortgages

Since mortgage rates generally run lower than home equity rates, it rarely makes sense to pay off your primary mortgage with an HE Loan or HELOC. In some cases, you might consider refinancing instead (see “Other ways to consolidate debt,” below).

Investments

A surprising large number of millennial homeowners — 30 percent — think making other investments (other than in the home, that is) a good reason to use home equity, the Home Equity Insights survey found. Investing is important, but going into debt to do so is a debatable move — especially given the current high cost of borrowing, which rivals any stock market returns (it was arguably a good strategy a few years ago, when loan interest rates were at historic lows). And a crash in stock prices can erase the home equity you have spent years building up. Avoid using a home equity loan for investments: Better to use savings or earned income, especially if you can invest via a company 401(k) plan.

How to apply for a home equity loan

Applying for a home equity loan will feel fairly similar to the process you went through to secure your first mortgage. Here’s a rundown of what you’ll need to do:

1. Know your borrowing power: Before you apply, it’s a good idea to figure out your credit score, estimate what your home is worth and calculate your equity stake. You’ll be more educated when you start comparing different lenders.
2. Look at different offers: Every lender is different, so you’ll want to do your research on closing costs, rates and other pieces of the fine print. You may want to start your search at the financial institution where you have a savings or checking account, or your primary mortgage. Some lenders offer rate discounts for existing customers.
3. Complete a formal loan application: You’ll need to submit paperwork verifying your income and employment, along with any other necessary documents. You’ll have to agree to allow a hard pull of your credit history and score.
4. Get your home appraised: The estimate of what your home is worth isn’t the final word on your home’s actual value. Your lender probably will require an appraisal – which you will pay for – to determine the current market value of the home. An increasing number of lenders are using AVMs – automated valuation models – to skip the appraisal process, however.
5. Wait: Don’t expect to get the money immediately. While some lenders offer relatively fast funding for HELOCs – Figure, for example, can disburse funds in as little as five business days – getting full approval for a home equity loan can feel closer to the timeline for a first mortgage, with up to eight weeks of waiting.
6. Review and sign the closing documents: You’ll need to pen your autograph on a range of paperwork about your agreement to pay the loan back, along with the serious repercussions of failing to do so.
7. Receive the loan proceeds: Home equity loans are disbursed in one lump sum. Once you receive the money, you can use those funds to pay off your other debts.

Other ways to consolidate debt

Home equity loans aren’t your only option for debt consolidation. Before you hock your home, be sure to compare these routes, too:

• Personal loans: Even though personal loans carry higher interest rates than home equity loans, they don’t carry the weight of your home with them. If an emergency comes up and you can’t make payments, you won’t lose your home through a personal loan.
• Balance transfer credit cards: If the majority of your debt is through credit cards, you can consider transferring your balances to a new credit card that comes with an extended introductory period offering a 0% APR – meaning you won’t incur any interest charges on the amount, during a certain window of time (often up to two years). However, some card issuers may only allow you to transfer a certain amount – $7,500 or $10,000, for example. So, depending on the size of your debt load, you may still need to pay off some of it with interest. And keep an eye on what the new card’s interest will be after the promotional period ends.
• Cash-out refinance: Rather than taking out a second mortgage with a home equity loan, you can replace your original mortgage altogether – and borrow even more – with a cash-out refinance. The additional amount you can get in cash is based on the amount of home equity you have built up. This move makes the most sense if you can score a lower rate with the new loan.
• Debt consolidation loans: There are loans specifically designed for combining and paying off debts. Some of the best lenders offer rates that can rival home equity rates if your credit is excellent. However, the terms tend to be much shorter. While home equity loans may offer 20-year repayment terms, debt consolidation loans tend to work on tighter timelines – often five years or less.
• Debt management plan: Nonprofit credit counseling agencies can work with you to create a plan that’s best for your finances. An agency will negotiate your rate and payment with lenders so you can get on a plan that won’t put you in a financial bind. You’ll make one monthly payment to the counseling agency, and then it’ll pay your debt off for you. There’s a big difference between non-profit counseling companies and for-profit counseling, though, so do your research and read past customer reviews before choosing one.

FAQ

• Who is eligible for a home equity loan?

  The requirements for a home equity loan vary from lender to lender. Generally speaking, you’ll likely need at least 15 percent equity in the home and a good credit score. To secure the lowest rate, you’ll want to take steps to boost your credit score, aiming for a 740.

• Who should use a home equity loan?

  Anyone who has a significant ownership stake in their home can consider using a home equity loan. If you’re planning to use one for debt consolidation, it’s important to have a solid plan in place to tackle your debts and avoid additional overspending. Ultimately, the decision to get a home equity loan comes down to having confidence in your ability to make regular on-time payments to make sure you don’t risk losing your property.

• Do I need a good credit score for a home equity loan?

  The minimum credit score for a home equity loan varies by lender. For example, BMO requires at least 700, while Discover will consider scores as low as 660, and Figure sets the floor at 640. Keep in mind that your credit score isn’t the only piece of the puzzle, either. Lenders will look at your entire financial picture, including your debt-to-income ratio, your earnings record and your credit history.

• Can I get approved for a home equity loan if I have a lot of credit card debt?

  It may be possible to get approved for a home equity loan with significant credit card debt if your debt-to-income ratio is not too high. However, applicants with substantial debt may not be offered the most competitive interest rate on a loan.

• What are the other ways to borrow against home equity?

  If you don’t want to take out a second mortgage, you can consider replacing your current mortgage altogether – while tapping into the equity you’ve accumulated at the same time – with a cash-out refinance. This move makes the most sense if you can score a lower rate with the new loan (admittedly, problematic if you managed to get a rate in the record-low 3 percent range of early 2021). If you’re at least 62 years old, you may also want to explore a reverse mortgage, but you’ll need to be mindful of the potential complexities that this move can create for passing on the property to an heir.