Should you use a HELOC for debt consolidation?

Debt can stand in the way of your financial goals, cause stress, and even strain your relationships. For these reasons, it makes sense to use every tool in your arsenal to tackle bad debt. Homeowners looking to pay down debt quickly have a compelling option: their home equity. 

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If you are a homeowner on a journey to become debt free, you may be wondering, “Should I use a HELOC for debt consolidation?” In this article, we’ll cover everything you need to know about using HELOCs to pay debt.  

HELOCs: a brief overview

If you’re looking into tapping into your home equity to pay down debt, you’re likely already familiar with how a Home Equity Line of Credit (HELOC) works – but let’s review the basics. 

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A HELOC is a revolving line of credit secured by your home. The way a HELOC works is not dissimilar to a credit card – you have a maximum draw amount, and you can take money out up until that amount. When you pay down your balance, you become eligible to take out more funds. 

Draw vs. repayment 

There are two phases to a HELOC, draw periods and repayment. The draw period typically lasts for 10 years, while the repayment period lasts for 20 years. During the draw phase, you are not required to make payments towards the principal, only the interest. You pay interest only on the funds you use, not your maximum draw amount. 

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When it comes time for repayment, your payments switch to interest and principal, and you can no longer take out additional funds from your HELOC.  

Pros and cons of using a HELOC for debt consolidation

Let’s cover some of the pros and cons of using home equity to consolidate debt – as well as the specific benefits and challenges that come with a HELOC. 

Pros of using a HELOC for debt consolidation

There are many positives when it comes to using a HELOC as a tool in your journey toward becoming debt free. 

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• Competitive rates – HELOCs have some of the best rates available out of any financial tool on the market, so you’ll likely save a large amount on interest when you consolidate your debt.  
• Affordable monthly payments – Because making payments towards your principal is optional during the initial phase of a HELOC, you can structure your debt repayment in a way that makes sense for your budget. 
• Flexibility to tackle your debt the way you want – With a HELOC, you can take out more funds as you pay down your balance. That means you can consolidate additional debt at any time during the draw phase. 
• Built in emergency fund – Building an emergency fund is an important part of staying debt free, but it can take time, especially when you first begin working to eliminate your debt. A HELOC acts like an emergency fund, preventing you from taking on additional high-interest obligations. 

Cons of using a HELOC for debt consolidation

Here are a few cons to keep in mind before moving forward with using a HELOC for debt consolidation. 

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• Stringent qualification requirements – HELOCs come with a rigid set of qualification requirements, and are generally only available to homeowners with a credit score above 680 and a DTI under 43%. If your financial health has taken a hit as a result of your debt, you may find it challenging to qualify. This calculator can help you decide if a HELOC is an option for you. 
• Risk of foreclosure if you default – HELOCs, and all other forms of home equity financing, are backed by your home. That means you could put your home at risk if you fail to make the required payments. 
• Unpredictable monthly payments – A HELOC comes with a variable rate, which makes it more challenging to budget for the amount you need to spend each month. Additionally, the size of your required payments jumps sharply when the HELOC shifts from draw to repayment. 
• Potential to fall back into bad habits – A HELOC is a form of revolving debt, just like a credit card. If you have bad habits tied to this type of financing, it can be incredibly tempting to take on more debt than you intend. 

When is a HELOC for debt consolidation a good idea?

Whether a HELOC is a good idea for your debt consolidation journey or not depends on your unique financial situation. However, let’s cover some basic guidelines. 

When it’s a good idea

A HELOC for debt consolidation might be a good idea for you if: 

• You are disciplined enough to use only what you need from your line of credit. 
• Your monthly budget is flexible enough to handle the fluctuations that come with variable rate payments. 
• Your credit and income is in good-enough shape to qualify. 

When an alternative may be a better solution

You may be better off with another debt consolidation tool if: 

• The availability of a line of credit will prove too tempting. 
• Your monthly budget has limited room for unexpected variance. 
• Qualifying for a HELOC may be challenging for you. 

HELOC alternatives

If, for whatever reason, a HELOC is not the best choice for your debt consolidation journey, there are other options that could be a better fit. Let’s talk about HELOC alternatives to pay off credit card debt (and any other debt you’re working to eliminate). 

Home equity loan

How it works

A home equity loan acts like a second mortgage. Home equity loans come in a lump sum and with a fixed interest rate, meaning you know exactly how much you will be paying every month for the duration of the loan term.   

Qualification requirements

• A credit score above 680, though some lenders may go as low as 630 
• A DTI (debt-to-income ratio) of under 43%
• An LTV of under 85%

Why you might choose it instead

A home equity loan to for debt consolidation can be a great alternative to a HELOC for borrowers looking for more predictability and structure to their financial tool. 

Home equity investment

How it works

An HEI (home equity investment) is an alternative to traditional debt-based home equity financing products. Unlike home equity loans or HELOCs, there are no monthly payments. Instead, you repay with a share of your home’s future value at any time before the end of the contract. 

Qualification requirements

• A credit score above 500
• No income or DTI requirements
• Eligible property in a location where HEIs are offered
• Plenty of home equity 

Why you might choose it instead

An HEI can be a great alternative to a HELOC if you do not want to take on an additional monthly payment or find it challenging to qualify for a traditional home equity tool because of your debt. 

Cash-out refinance

How it works

You replace your existing mortgage with a new, larger loan and use the excess to pay off your debt. Cash-out refinances can be fixed or variable rate, and the term length varies – just like with your original mortgage. 

Qualification requirements

• A credit score above 580, although 620 is more common 
• DTI of under 50% 
• LTV of under 95%

Why you might choose it instead

A cash-out refinance streamlines your monthly payments, putting your debt and your housing under one bill. If you are looking for additional simplicity, this can be a good alternative to using a HELOC for debt consolidation – provided you can afford the new, larger mortgage payment and the potential change in rate. 

Personal loan

How it works

Unlike a HELOC or another home equity product, a personal loan is generally unsecured – meaning it is not backed by collateral. This means that your home is not at risk if you default on the loan, but also generally comes with higher rates to offset the added risk to the lender. Personal loan terms can vary, but generally range from 1 to 12 years. 

Qualification requirements

• A credit score above 600, although a higher score is needed to get a better rate
• DTI of under 36%, although some lenders who specialize in debt consolidation can go higher 
• A steady income 

Why you might choose it instead

If you wish to avoid putting your home on the line to consolidate your debt, and don’t mind a shorter repayment timeline, a personal loan can be a great alternative. 

Balance transfer

How it works

Credit card issuers offer promotional zero interest balance transfers as a carrot to entice new customers from other brands. With a balance transfer, you move your existing credit card balance to a new card in exchange for a percentage fee. You then get an interest-free period to quickly pay down your balance, typically 24 months. 

Qualification requirements

• A credit score above 670
• A maximum limit high enough to accommodate the entire balance you are transferring

Why you might choose it instead

If you want to make progress on your debt fast, a zero interest promotional period can be a powerful tool – provided you can eliminate the balance in question before the promo ends. This is another unsecured product, meaning it is not tied to the value of your home. 

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FAQs

Is it wise to use HELOCs to pay off debt?

This depends on your specific financial situation. Cosider using a HELOC to pay off debt if you qualify for a good rate, can afford the monthly payments, and can be disciplined about using the line of credit.  

Is there a downside to having a HELOC?

HELOCs may come with certain fees, including annual fees and draw fees. If you do not make your payments, your home could be at risk. 

Does a HELOC hurt your credit?

As long as you make timely payments, and are mindful about utilization, a HELOC is not likely to hurt your credit. 

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Final thoughts

The journey to becoming debt free is not always easy, but you have a variety of tools at your disposal to help make your dreams of financial freedom a reality. Explore all your options to find the best fit for you. Prequalify today to see how much you can get with Point’s HEI, an alternative to using a HELOC for debt consolidation.