How to use a home equity loan for debt consolidation

Debt can sometimes be a roadblock to the life you want. Consolidation could help you streamline your budget, pay off what you owe in less time than making your minimums, and maybe even save a little money along the way.

Personal loans are a common way to consolidate debt, but you may also have another option. If you own your home, you could qualify for a home equity loan for debt consolidation. Using home equity to pay off debt has some advantages, including lower interest rates than many other types of credit. 

Intrigued? We'll walk you through how the process works and when it might make sense for you. 

What is a home equity loan and how can it help you pay off debt? 

A home equity loan is a loan that's secured, or backed, by your home. That's why home equity loans are sometimes called a second mortgage. If you don't repay a home equity loan, the lender could sell your home to get its money back.

The amount you can borrow is determined largely by your home's equity value. Home equity is the difference between what your home is worth and what you owe. For example, if you own a home that's worth $500,000 and you owe $300,000 on your mortgage, you have $200,000 in home equity.

Home equity loans are installment loans, so you get a lump sum that you pay off over time—typically 10 to 20 years. You may also choose a home equity line of credit (HELOC), which is like a reusable home equity loan; you can pay it off and then borrow again during the draw period.

To consolidate debt with a home equity loan, you use the proceeds from the loan to pay off credit cards and other bills you want to consolidate. Essentially, you replace your old debts with a new loan, ideally at a lower, fixed interest rate. 

What types of debt can you pay off with a home equity loan? 

Home equity loans offer a lot of flexibility, since you can decide how to use the money. What kinds of debt can you pay off with a home equity loan? You could consolidate a variety of debts, including credit cards, store cards, personal loans, or medical bills.

Using a home equity loan for debt consolidation is usually best for fixed debt amounts you plan to pay off over time and for unsecured debts. Unsecured debts aren't attached to any collateral, like a home or a vehicle you own. When you use a home equity loan to pay off unsecured debts, you essentially convert the balances to secured debt. 

Can you use a home equity loan to pay off credit cards? 

Yes, many homeowners use a home equity loan to pay off high-interest credit card balances. A home equity loan enables you to combine multiple debts into one fixed-monthly payment—often with a lower interest rate. 

Can you use a home equity loan to pay off private student loans or a car loan? 

Technically yes, if your lender allows it. Using a home equity loan to consolidate student loans or auto loans isn't common, however, and it usually isn't a great idea, either. 

Why? Private student loans may have lower interest rates than credit cards or home equity loans. And lenders might offer flexible payment options, so consolidation with a home equity loan may not yield any benefits. You could pay off a car loan with a home equity loan, but you might not save any money if there's little to no difference in rates. 

Should you use your home equity to pay off debt?

Using a home equity loan to consolidate debt could make sense if you:

• Mostly owe unsecured debts

• Don't plan to use your cards again after you pay them off

• Can quality for a lower interest rate on a home equity loan than what you currently pay to your debts

Regardless of the type of debt you have, it wouldn't make sense to consolidate with a home equity loan if doing so means you'd end up with a higher interest rate. You'd only cost yourself more money and potentially delay your arrival at debt freedom. 

Here's a closer look at the benefits and disadvantages of using a home equity loan to pay off debt. 

Benefits:

• Home equity loans tend to have lower interest rates than credit cards or personal loans.

• Your lender may be able to pay your creditors directly, which leaves you with one less thing to worry about. 

• You'll have just one monthly payment to keep up with, which streamlines your budget.

• Some lenders will approve you with a lower credit score. At Achieve, for example, you can apply for a debt consolidation home equity loan with a credit score of 640.

Drawbacks:

• Your loan is secured by your home. If you don't repay it, you risk losing your home to foreclosure.

• A longer loan term could mean you pay more interest overall. 

• You may be tempted to use your credit cards again and create new debt. 

• Debt consolidation doesn't reduce the amount you owe. 

If the last drawback is a sticking point for you, consider a debt consolidation alternative like debt settlement. When you settle a debt, your creditor agrees to accept less than the full balance due to get rid of your debt. The remainder of the debt is forgiven. 

Debt settlement is a legal way to get out of debt without paying in full, but it may fit some situations better than others. Contact a debt relief expert to talk about your options.

How to get started if a home equity loan seems right for you

If you think a home equity loan for debt consolidation could be a good fit, the first step is to estimate how much equity you have. Here's how:

• Find your latest mortgage statement, and look for your current outstanding balance.

• Get an estimate of your home's value from a trusted site like Realtor.com, Zillow, or Redfin. 

• Subtract what you owe from the estimated value. The difference is your equity.

For example, if you owe $320,000 on a home valued at $720,000, you have $400,000 in equity. 

Your estimated equity number is a guide for you, not what a lender uses to approve you for a home equity loan. Once you apply, the lender will schedule a professional appraisal to get an accurate market value. 

Armed with this knowledge, you can get prequalification offers from a lender. Prequalification allows you to estimate the loan size and interest rate you might qualify for, based on the lender taking a cursory look at your finances. 

Tip: Look for a lender like Achieve that offers prequalification with no hard credit pull. 

Compare a few prequalification offers to see which offers the terms that fit your needs best. Then, it's time to apply. 

Here's a general idea of what you can expect when you apply for a home equity loan:

• Gather the paperwork you'll need. That includes bank statements, recent pay stubs, tax returns, or a profit and loss statement if you run a business. 

• Submit your application to the lender, along with your income and bank account documents. Many lenders accept applications online, though you might need to apply in person if you're borrowing from a smaller, local bank. 

• Pay the appraisal fee and wait for the appraiser's report. 

• If approved, head to the closing table. Pay closing costs and sign the loan paperwork.

• Wait for your home equity funds to hit your bank account, which may take anywhere from three to seven days. 

If you asked your lender to pay your creditors directly, you'll get any money that's left over. Otherwise, you'll need to schedule bill payments to your debts once the loan deposit clears your account. 

What if your appraisal comes in too low? You could appeal to the lender to ask for reconsideration. Or you might volunteer to pay for another appraisal from a different company. If the value still comes in too low, you might have to put off borrowing until you build up a little more equity. You could also consider a personal loan for debt consolidation instead.