Step-by-step guide to using a HELOC to get out of debt

A home equity line of credit (HELOC) is a credit line that lets you borrow against your home equity. That’s how much it's worth minus how much you still owe on your mortgage. A HELOC is a mortgage and your home is the collateral.

Generally, HELOCs have lower interest rates than credit cards, or even many personal loans. A HELOC can be a powerful tool for helping you put your debts behind you, so long as you have a solid repayment plan. 

Lets go over the basics of a HELOC and how to use a HELOC to pay off debt.

How a HELOC works

A HELOC is a revolving credit line, which means you can use it over and over again, similar to a credit card. However, a HELOC isn't designed to be swiped at the store. Instead, it's intended to be used for large expenses. Some lenders even have minimum withdrawal amounts.

A HELOC has two phases: the draw phase and the repayment phase. During the draw phase (typically 5-10 years), you can borrow, repay, and borrow more, as often as you like, up to your limit. 

Then, during the repayment phase, you can’t borrow more. From that point, you’ll make monthly payments for the number of years that you chose when you got the loan (typically 10-30 years). 

Some lenders allow you to make interest-only payments during the draw period. The advantage is that the payment amount is as low as possible. The disadvantage is that you could make payments for years and still owe the same amount. Interest-only payments don’t make a dent in your balance.

Achieve Loans requires a full principal plus interest payment, including during the draw period.

As long as you make your payments as agreed, a HELOC could be a great way to consolidate debt. If you don't make your payments, you could be at risk of foreclosure and possibly lose your home.

If it sounds like a HELOC is for you, here's a step-by-step guide on how to use a HELOC to pay off your debt.

Step 1: Evaluate your current debts

Before you can do anything else, you need to know exactly where you stand. Make a list of all your debts, including balances and interest rates. This will let you know how much you need to borrow and how much it’s costing you. This is one way you’ll know if it makes sense to use a HELOC to consolidate your debts.

While you're at it, list out all of your other expenses, and your income, so you can see a bigger picture of your financial situation. Fill in more of this financial picture by estimating how much you can afford to pay each month on your HELOC (see Step 4).

Step 2: Estimate your home equity

Home equity is the difference between the value of your home and how much you still owe. In other words, home equity is the amount of your ownership stake. For example, if your home is appraised at $500,000 and you owe $215,000 on your mortgage, you have $285,000 in home equity:

500,000 - 215,000 = 285,000

Generally, a HELOC lender will let you borrow a percentage of your home’s value. The limit often falls between 75% and 85%, and it includes your existing mortgage balance. Lenders use a calculation called combined loan-to-value (CLTV) to determine how much you could borrow.

If your lender has a 75% CLTV limit, then the total debt you could have against your home is $375,000.

500,000 x 0.75 = 375,000

You’ve paid your mortgage down to $215,000, so that means you could apply for a $160,000 HELOC.

215,000 + 160,000 = 375,000

The exact amount you could qualify for will ultimately depend on many factors, including your credit score, your income, and how much other debt you have. 

Your HELOC lender will verify the value of your home and do the CLTV calculation themselves. If you want a preliminary estimate, check your home’s value on a real estate site like Zillow or Redfin. Subtract the balance of your mortgage for a general idea of how much equity you have.

Step 3: Check your credit reports and scores

As with any type of loan, a HELOC involves a credit check to look at your credit history and scores. The higher your credit scores, the better your HELOC terms will likely be, including lower interest rates.

You can get a free copy of your credit reports from all three major credit bureaus (Equifax, Experian, and TransUnion) for free every week. Get them by visiting AnnualCreditReport.com. If you see anything that doesn't look right, such as an error or an account that isn't yours, dispute it with the credit bureau reporting the error. It’s a good idea to fix your credit before you apply for a HELOC.

Step 4: Create a HELOC repayment plan

The best way to go into a HELOC is to know exactly how you're going to repay it before you start filling out applications. Your home is the security for your credit line—be certain you can keep up with repayments so you don't put your home at risk.

You can use online loan calculators to estimate your monthly payment based on average interest rates and how much you're borrowing. Plug those numbers into your monthly budget to make sure you have plenty of room to manage your payments each month.

Your repayment plan should also outline how you're going to handle your expenses going forward. A budget should be a regular part of your money management strategy. Periodically review your fixed expenses as well as variable ones, like meals out and clothes, and always be on the lookout for costs you can cut. Any dollar you save is a dollar you could put toward getting rid of your debts for good. 

Paying off your existing debt with a HELOC is the right move only if you deal with how you got into that debt in the first place. Lots of us get into debt because of factors beyond our control (death, healthcare, divorce, and so on). But if the debt resulted from overspending, that’s a problem a HELOC won’t solve. In that case, take a mindful approach to your plan for avoiding debt in the future before you borrow more.

Step 5: Find a HELOC lender and apply

Once you have your ducks in a row, it's time to get your HELOC. Shop around and compare offer terms from a few lenders before making your decision.

Here are a few things to consider when looking for a lender:

• Where you go matters. Credit unions and online lenders may have lower rates and more flexible application requirements than brick-and-mortar banks.

• Pick the right type of interest. A fixed interest rate means you have the same rate for the life of your loan. A variable interest rate is more unpredictable and can change over time.

• Compare costs. Most lenders charge closing costs or other fees for a HELOC, so read all of your fine print.

• Pay attention to minimums. Be aware of the requirements for withdrawals, including minimums.

Step 6: Stick to your plan and stay out of debt

After you get your loan money and use it to pay off your old debts, it's time to launch your repayment plan. Keep up with your monthly payments and work on getting your balance down as quickly as your budget allows.

You also want to stay on top of your other expenses so you don’t take on new debt. If you avoid new debt and keep up with your payments, you can reach that longed-for debt-free state.