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Should you use a home equity loan for debt consolidation?

December 17, 2022, 4:39 PM UTC
Decorated living room at home
Using home equity to consolidate debt may not the right choice for everyone.
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This article was originally published on Bankrate.com.

A home equity loan allows you to convert a portion of the equity you’ve built in your home to cash. It’s also an effective way to consolidate debt and eliminate high-interest credit card and loan balances sooner. That’s because the average interest rate on home equity loans is often lower than that of a credit card.

These loans aren’t without risk, though. You’ll increase your debt load, and your home could be foreclosed if you fall behind on payments. Weigh all your options to decide if a home equity loan is best to consolidate your debt.

Should I use a home equity loan to consolidate debt?

Because home equity loans and home equity lines of credit (HELOCs) have relatively lower interest rates, they’re a viable option for homeowners who could save money by refinancing their high-interest debts at a lower interest rate.

“Borrowers who are serious about paying off their unsecured debt should consider a home equity loan for debt consolidation,” says Laura Sterling, vice president of Marketing for Georgia’s Own Credit Union. “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 is usually an advantageous option.”

However, using home equity to consolidate debt is not the right choice for everyone, especially if you aren’t responsible with debt management or repayment. If you’re late repaying your home equity loan (or, worse, miss the payments altogether), you could put your home at risk of foreclosure. It’s crucial to address the root cause of your debt before taking on another loan.

Pros of using home equity for debt consolidation

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.

“Many people have a hard time juggling multiple bills every month, and making sure all are paid on time,” says Joseph Toms, president and chief strategy officer for JG Wentworth. “Having just one payment to take care of can ease the stress and help many people ensure on-time payment.”

Lower interest rate

A home equity loan generally comes with a lower interest rate than other types of loan products since your home serves as collateral for the loan. If you have outstanding debt on a credit card, a personal loan, student loans or other debts, consolidating with a home equity loan could make it cheaper to pay off those debts.

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 for debt consolidation

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

Secured by the home

The main consideration in using your home’s equity for debt consolidation is that your home serves as collateral for a home equity loan. This means that if you default on your home equity loan, your lender could foreclose on your home. If you’re having trouble making existing payments, you may want to find other ways to consolidate debt.

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. For instance, if you have a mountain of credit card debt, pay it off and then continue to rack up more credit card debt, you’re making your debt worse. Now you’ll owe a home equity loan payment as well as credit card payments.

Possible fees

Since home equity loan lenders rely on your home’s current value to determine how much you can borrow, you might need to pay for an appraisal. You might also be on the hook for closing costs. If you have a lot of debt to consolidate, paying these extra fees might still make sense, but it’s wise to compare the fees you would have to pay with the amount you’d ultimately save in interest.

How do I get a home equity loan for debt consolidation?

The application process for a home equity loan is similar to what you experienced when you applied for a mortgage. It generally involves:

  • Getting a preapproval to gauge your borrowing power
  • Completing a formal loan application
  • Submitting income and employment information, along with any additional documents the underwriter needs to process the loan application
  • Having your home appraised
  • Reviewing and signing the closing documents
  • Receiving the loan proceeds (home equity loan)

“The process could take up to 60 days, similar to a mortgage refinance,” says Vikram Gupta, head of Home Equity for PNC Bank. “At closing, the lender can often send the debt payments directly to other lenders and consolidate the debt into the new home equity loan.”

Do you need good credit to get a home equity loan?

Generally, you’ll need a credit score of at least 620 to qualify for a home equity loan, but some lenders offer this type of loan even if you have a lower score or bad credit. This assumes, however, that you have adequate equity in your home (at least 15 percent or 20 percent) and a lower debt-to-income (DTI) ratio, preferably under 43 percent. If you’re seeking a home equity loan to consolidate debt, the latter might not add up for you.

Other ways to consolidate debt

A home equity loan isn’t the only choice you have for debt consolidation. Before choosing it, compare all of your options.

  • 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 transfer your balances to a 0 percent APR balance transfer credit card. These offers are typically temporary, but they might give you enough time to move your balances over and pay them off without the extra interest costs. Keep in mind that not all card issuers will approve your full balance; if you have lots of debt, you may still have to pay off some of your old cards with interest.
  • Debt management plans: Nonprofit credit counseling agencies can work with you to create a plan that’s best for your finances. It 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.

How do I get started?

If you’ve decided that a home equity loan is your best option for consolidating debt, start by comparing lenders, offers, rates and terms. If you can’t get better terms or a lower interest rate than what you have on your existing debt, keep looking at what other lenders offer. Having a plan for how you’ll attack high-interest debt — and how you’ll repay your home equity loan — can set your finances up for a more secure future.

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