Using a home equity loan for debt consolidation

If you own your home and have been building equity in it, you may have an option that could simplify and potentially reduce the cost of your existing debts.

A home equity loan is a one-time loan against your home. The interest rate is typically fixed and lower than the rates on most credit cards or personal loans. You may be able to use this type of loan to consolidate higher-interest debt into a single, more manageable monthly payment. 

How a home equity loan works for debt consolidation

A home equity loan is a mortgage. If you're still paying down the mortgage you got when you bought your home, the home equity loan will be a second mortgage. You borrow a specific amount, receive it as a lump sum, and repay it over a set term, often five to 30 years. 

To find out if you qualify, lenders generally look at your credit score, debt-to-income ratio, and how much home equity you have.

How much can you borrow?

The amount you can borrow with a home equity loan depends on  your home's current value, your remaining mortgage balance, and the lender's home equity loan limits.

Your lender takes your combined-loan-to-value, or CLTV, ratio into account when determining how much you can borrow. CLTV is calculated by adding all of your outstanding home loan balances and dividing that number by the current market value of your home.

For example, if your home is worth $400,000 and you owe $250,000 on your primary mortgage, you have $150,000 in equity. A lender allowing up to an 80% CLTV on a $400,000 home would cap total borrowing at $320,000. After accounting for the $250,000 you already owe, the lender might offer up to $70,000 with a home equity loan.

Types of debt to consolidate with home equity 

A home equity loan works best for higher-interest debts. It wouldn’t make sense to pay off a debt using a loan that has a higher interest rate. Common balances people consolidate with home equity loans include:

• Credit card debt. Credit cards tend to carry the highest rates, so they're often the first target if you consolidate debt with home equity.

• Personal loans. If you took out a personal loan at a high rate, you could fold it into a home equity loan.

• Medical bills. Large medical balances, especially those transferred to credit cards or payment plans, could be consolidated into a single payment.

A home equity loan isn't only for debt. People also borrow against their equity for other goals, such as remodeling a home or buying property. For a fuller picture of what home equity can fund beyond consolidation, explore these ways to use a home equity loan.

How to consolidate debt with a home equity loan

If you think a home equity loan for debt consolidation could fit your situation, the process follows several steps.

1. Evaluate your debt 

List every balance you might consolidate, along with its interest rate and minimum payment. Your list shows you which debts are costing the most and confirms whether consolidation could lower your interest rate.

2. Determine how much you want to borrow 

Add up the balances you plan to pay off, and consider whether you want to cover any other large expense at the same time. Borrow only what you need. A smaller loan means less interest over time and less risk against your home.

3. Check your credit

Review your credit reports and scores before applying. You can get your credit reports for free from AnnualCreditReport.com. Many banks and credit card issuers offer free credit scores that you can access by logging into your account. If yours doesn’t, search for free credit scores online. Most lenders look for a credit score of at least 620.

4. Check your home equity 

First, check your home’s current value on a real estate website. The lender will do their own valuation, but this should give you a ballpark. Then, estimate your available equity by subtracting your remaining mortgage balance from your home's current value. Your equity is one of the main factors that determines how much you could borrow.

5. Find a lender 

Prequalify with Achieve Loans. We offer fixed-rate HELOCs that you may use for debt consolidation if you qualify. We do a soft pull on your credit, which doesn’t affect your score. 

It’s a good idea to check with more than one lender so you can compare rates, closing costs, and funding timelines. 

6. Apply for the loan 

Submit your application with the required documentation, such as income verification, your mortgage statement, and proof of homeowners insurance. Complete documents up front to help avoid delays.

7. Receive your funds and pay off creditors 

If you’re approved, after closing you’ll receive the loan as a lump sum. Some lenders, including Achieve Loans, are willing to pay your other creditors directly; others send the funds to you to distribute. Either way, apply the money to the balances you set out to consolidate. Then focus on repaying the single new loan.

Potential benefits of using a home equity loan to pay off debt

Using a home equity loan for debt consolidation has some advantages:

• A potentially lower interest rate. Home equity loan rates are typically well below credit card APRs and may be lower than personal loan rates because your home secures the loan. Advertised rates reflect a narrowly defined low-risk borrower with a high credit score, low CLTV, and strong income, so the rate you're offered may be different.

• One monthly payment. Combining multiple debts into a single monthly payment could simplify your finances and lower the chance you'll miss a due date.

• A predictable payoff timeline. Unlike credit card minimum payments that can stretch debt out for years, a home equity loan has a fixed term with a defined end date.

Potential drawbacks of using a home equity loan to pay off debt 

Using a home equity loan to pay off debt has some drawbacks worth thinking through carefully:

• Your home becomes collateral. If you can’t repay your home equity loan, you could lose your home. 

• Closing costs usually apply. Home equity loans typically come with closing costs of 2% to 5% of the loan amount. On a $50,000 loan, that’s $1,000 to $2,500 upfront, depending on the lender.

• Consolidation doesn't address the causes of debt. Examine why you're in debt. If you're still working on money management, create a plan before you get the new loan. If you get a home equity loan and then run up new balances on your credit cards, you could end up in a worse financial situation. 

When a home equity loan could make sense for debt consolidation

Using a home equity loan to consolidate debt could make the most sense when:

• You have sufficient equity in your home.

• You have a stable income and a realistic plan to repay the loan.

• Your debt carries high interest rates relative to what you'd pay on a home equity loan.

• Your total debt is manageable relative to your income.

When a home equity loan may not be the right move

A home equity consolidation loan may not be a good idea if:

• Your income or employment is unstable.

• Your debt load is large relative to your income, which may suggest that debt relief is worth exploring instead.

• You've consolidated debt before, but it didn’t break the cycle of accumulating debt.

• You're close to retirement and prefer not to take on new secured debt.

Alternatives to consider to home equity loans for debt consolidation

A home equity loan isn't the only way to consolidate and pay off debt. Other options may carry less risk or be a better fit for your situation.

Personal loan

A personal loan for debt consolidation doesn't use your home as collateral. Rates are typically higher than home equity loan rates. If you don’t want to borrow against your home but want predictable monthly payments, consider looking into a personal loan.

Balance transfer credit card

A balance transfer card could give you a way to move multiple credit card balances onto a single card, often with a low or 0% introductory rate for a set period (frequently 12 to 18 months). 

If you have good credit and think you can pay off the balance relatively quickly, this could be a good option. But if you need more time, a balance transfer could be costly. Any balance you don't pay off by the end of your introductory period becomes subject to the card's standard APR, which is often a much higher rate than a home equity loan rate.

Balance transfers can turn into a juggling act. You might repeatedly try to move unpaid balances to a new balance transfer card and start running out of offers. Or you might end up with multiple balances that you didn’t have before. It’s a good idea to consider a balance transfer as a one-time strategy that’s part of a clear plan to put your debt behind you.

Debt relief

If your debt is overwhelming, debt consolidation might not be the right path. If you genuinely can’t afford to fully repay your debts and you don't know how you’ll deal with them, you may want to consider a debt relief program. With a debt relief program, you may be able to settle your debt for a lower amount than what you owe. 

How to decide if a home equity loan for debt consolidation is right for you

Before deciding to use a home equity loan to pay off debt, ask yourself some key questions:

• How stable is my income now, and is it likely to stay that way? 

• Can I comfortably keep up with home equity loan payments?

• Am I comfortable borrowing against my home?

• Have I compared the total cost of a home equity loan, including closing costs, to other options?

Achieve offers home equity loans as well as debt relief programs. Talk to a debt expert to explore different paths before making a decision.