Is it wise to take on a new loan when you have debt?
By Miranda Marquit
Nov 17, 2023
Read time: 3 min
It’s always smart to approach new debt cautiously especially when you already have debt you’re working to pay off. But new debt isn’t always bad.
One way you could make progress against high-interest debt is to borrow against the equity you have in your home. If you qualify, you might be able to consolidate other debts, lower the cost of your debt, or make your monthly payments more manageable. Done right, a new home equity loan could bring your financial stress level down and help you get rid of your debt.
That’s right. Taking out another loan when you have debt might make sense—especially if you have a realistic plan. Let’s take a look at how borrowing against your home equity might improve your finances.
What is a HELOC?
A home equity line of credit, or HELOC, is a revolving line of credit. It’s similar to a credit card but with key differences:
A HELOC is a secured loan. It’s guaranteed by your home. If you fail to repay the debt, you could lose your home.
Most credit card accounts are unsecured debt. You qualify based on your creditworthiness only. If you fail to repay the debt, the creditor can sue you for it.
A HELOC allows you to borrow, repay, and borrow more for a few years, called the draw period. After the draw period, you’ll enter repayment and pay off the loan in equal monthly installments. During the draw period, some lenders require that you make a principal plus interest payment every month, based on your current balance and loan term. Others may allow you to make interest-only payments. If you do this, expect your monthly payments to spike when the draw period ends. Also, when you make interest-only payments, you don’t make any progress toward paying down the debt.
A credit card account can stay open and usable indefinitely. This feature keeps some people trapped in debt.
The credit limit on a credit card is only based on your credit profile. A six-figure limit is very rare and only offered to affluent, big-spenders.
When you get a HELOC, you only borrow what you need. If you don’t need to borrow your full credit limit, you don’t have to. Interest is only charged on the amount of the credit line you use.
When it may be wise to use a HELOC to pay off high-interest debt
HELOCs tend to have lower interest rates than credit cards. That’s because your home guarantees the loan. If you get a HELOC, you could withdraw money to pay off higher-interest credit cards. When you do this with multiple credit card accounts, you’re consolidating debts with a home equity loan. If you can’t get better terms on the new loan, it might not be a good idea to consolidate.
When you lower the interest rate on your debts, your finances could improve in a couple of ways:
If you keep making the same monthly payment, more of your money will go toward knocking the balance down, and you could get rid of the debt faster than you would by opting for a lower payment.
If you opt for a lower payment, you could free up cash in your budget while paying down the debt.
Example of using a home equity line of credit to pay down debt
Here’s how it might work. Say you have four high-interest balances:
$5,000 at 29.99% (minimum payment $200)
$6,500 at 26.99% (minimum payment $260)
$3,000 at 18.99% (minimum payment $120)
$4,800 at 25.99% (minimum payment $192)
Total debt: $19,300
Total monthly payment: $772
Let’s look at potential payoff scenarios. Achieve doesn’t offer the option to make interest-only payments, so these examples assume you’ll make a principal plus interest payment every month, including during the draw period.
Option 1: Credit card minimum payments
If you make minimum payments (which get smaller as your balance goes down), you’ll take 19 years to pay off these debts. In addition to the amount you owe, you’ll pay nearly $24,000 in interest.
Time to payoff
Total interest paid
Option 2: 10-year debt consolidation HELOC
Let’s say you qualify for a HELOC with a 12% interest rate. You could borrow $20,250 and have enough to cover the lender fees and all four debts. (Lender fees are usually between 2% and 5% of the loan amount.) If you don’t borrow more during your draw period, you could pay off this debt in 10 years at $291 per month. Your total interest would be $14,613.
Time to payoff
Option 3: HELOC with additional payment
What if you want to knock down the debt even faster? Choose a lender that doesn’t charge a prepayment penalty for paying off the loan ahead of schedule. If you can afford to pay $500 per month and you don’t borrow more during the draw period, you still get relief in your budget (over $200 per month), but you could pay off the loan in 52 months. Your total interest would be $5,818.
Time to payoff
4 years 4 months
Option 4: HELOC with power payment
Your last option would be to stick with that $772 monthly payment. This would add rocket fuel to your debt payoff strategy. You could clear your debt in about 2 1/2 years if you don’t borrow more, and you’d only pay $3,401 in interest.
Time to payoff
2 years 6 months
Make a plan to use your new HELOC to get rid of debt
For a smart financial strategy to work, you need to plan it carefully. The biggest risk of any debt consolidation loan is that you could charge the credit cards back up after you pay them off with a new loan. That could leave you in a deeper financial hole. Some people close their credit cards after paying them off with a debt consolidation loan to lower the risk of adding more debt.
If you make a plan and stick to it, you can reduce your risk and get rid of your debt on schedule. To find out more about a home equity loan from Achieve, get started here and talk to an Achieve Loans advisor.