Should you use a home equity loan for debt consolidation?

Are you looking to take control of your financial future? For the average person, that journey begins with eliminating debt. Whether you want to live a debt-free lifestyle or hope to achieve a specific dream, debt can prevent you from accomplishing your goals.

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With debt consolidation, you can combine your balances into one monthly payment — often with a lower interest rate — and improve the payoff journey. This post will explore the workings of using a home equity loan for debt consolidation, the pros and cons, and the alternatives to consider.

What is a home equity loan?

A home equity loan allows you to borrow against the equity in your property for a lump sum of cash. Repayment involves monthly payments with a fixed interest rate over a set term, typically 5-30-years.

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When considering debt consolidation, home equity loans offer better rates than other products. Additionally, there's no restriction on how you can use your funds, which means you can consolidate whatever debt you need to.

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Home equity loan requirements:

• A combined loan-to-value ratio (CLTV) of 80-85% or lower
• A credit score of 620 or higher
• A debt-to-income ratio of 43% or lower
• Sufficient income

The pros and cons of using a home equity loan for debt consolidation

Pros

‍Lower interest rate

Since your property secures the loan, it often has a lower interest rate than other options, like personal loans and credit cards. By refinancing your high-interest debt at a lower rate, you can save hundreds, or even thousands, in interest.

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Fixed interest rate

Unlike credit cards, home equity loans offer a fixed interest rate — protecting homeowners from a volatile market. As a result, you'll have predictable monthly payments throughout the life of the loan.

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Single monthly payment

If you have multiple debts with various due dates, managing them effectively can be daunting. Consolidating your balances into one payment can streamline the payoff process and reduce the risk of a late or missed payment.

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The ability to pay down debt faster

Lower rates tend to reduce the minimum monthly payment owed. By freeing up more of your cash flow, you can chip away at debt more quickly, should you choose.

Cons

Fees and closing costs

Home equity loans have fees and closing costs that you'll be on the hook for. This includes origination, title, appraisal fees, and closing costs. It's critical to weigh these expenses against the cost savings benefit to determine if it's right for you.

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The potential for an underwater mortgage

If your home value declines, you can potentially owe more than your home is worth. When you have an underwater mortgage, selling or refinancing can be challenging — unless you can cover the expenses out of pocket.

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Reduced equity

Tapping your home wealth to achieve goals is a sound strategy. By leveraging equity to consolidate debt, you'll be limiting your flexibility in the future. You'll likely have to increase your home equity to draw on it again. However, taking out multiple home equity products on the same property is not impossible.  

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Risk of losing your home

A home equity loan uses your property as collateral, so a lender may foreclose on your home if you fail to make payments.

When does a home equity loan for debt consolidation make sense?

A home equity loan may be a sound idea if:

• You'll save more than you spend.
• You're struggling to manage multiple monthly payments and want to simplify your finances.
• You're confident in your ability to repay the loan.

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A home equity loan may not be worth it if:

• You're not prepared to stop taking on new debt.
• You won't say due to fees and closing costs.
• You have student loans that could lose federal protection if you refinance to a private lender.
  

Tips for successfully consolidating debt

• Explore your options: It's unlikely that the first lender you encounter will offer the best terms. Instead, shop around, comparing rates, terms, and reviews. Doing so will help you secure the best option for your unique needs.
• Borrow only what you need: Receiving a large influx of cash is always exciting — however, it's still debt. Avoid going further into debt by limiting your funds.
• Avoid new debt: Once you consolidate your debt, you'll have room to start spending on your credit cards again. Consider closing or freezing your accounts to stop using them.
• Prioritize loan repayment: Breaking the debt cycle often involves adopting better financial habits. To stay on track, you can budget and live frugally. If you're looking to pay down debt as quickly as possible, consider cutting expenses.

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Home equity loan alternatives

Depending on your debt repayment needs and financial health, home equity loan alternatives may be better suited to help you get your finances back on track.

Home equity line of credit

A home equity line of credit (HELOC) works similarly to a credit card. During the draw period, typically 5 to 10 years, you can borrow funds up to a predetermined limit. Once the draw period ends, your balance becomes a principal-plus-interest loan. You'll be responsible for monthly payments with a variable rate over a 10-to-20-year repayment term.  

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Since a HELOC offers revolving credit, it can help with long-term bills or anticipated debt, like future significant investments.

Home equity investment

A home equity investment (HEI) is another way to tap into your home equity for debt consolidation. You can access a lump sum of cash in exchange for a share of your home's future appreciation. Unlike an equity loan or HELOC, there are no monthly payments. Instead, you repay your investment through a home sale, refinance, or other source of funds at any time during the 30-year term.

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HEIs have less stringent requirements—no income criteria or need for perfect credit—which makes them particularly accessible to borrowers with less-than-great credit.

Cash-out refinance

A cash-out refinance replaces your existing mortgage with a larger one and pays you the difference in cash. When you refinance your home, you'll get new loan terms and a new rate. It's best to refinance only if you can secure a lower rate than your previous one.

Credit card balance transfer

A balance transfer allows you to move high-interest credit card debt to a card with a lower rate or promotional period of 0% interest. However, these rates are temporary — lasting anywhere from 12-18 months — and can make it more challenging to pay off the debt once the promo rate is gone.

Personal loan

Personal loans often offer better rates than credit cards, making them appealing to some consumers. The rates are tied to your credit score and can be fixed or variable, depending on the lender. It's also essential to assess whether the terms charge for early repayment — if so, it's unlikely you'll save over the life of the loan. Ultimately, you'll still be on the hook for monthly payments.

The bottom line

Managing debt can quickly feel overwhelming. However, since most homes increase in value over time, leveraging equity to consolidate debt has never been easier. Homeowners can take advantage of home equity loans or other home equity loan alternatives to help tackle debt and take control of their finances.

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Point is a homeowner-first solution for debt consolidation. With no monthly payments and the ability to maintain control over your home, an HEI is an effective solution for homeowners. If you've been rejected from conventional financial products, you may still be eligible for an HEI with Point. Contact us to learn more about HEIs and how they can help you get a financial fresh start.