Should you use a home equity loan for debt consolidation?

Are you looking to take control of your financial future? For many, the journey begins with tackling debt.

Luckily for homeowners, rising tappable equity makes debt consolidation more accessible than ever. One popular tool for doing so is using a home equity loan. While a home equity loan for debt consolidation can provide much-needed relief, it’s not without costs and risks. 

Here’s a look at how home equity loans for debt consolidation work and what you need to know before using one.

Why use a home equity loan for debt consolidation?

Using a home equity loan can be a smart approach to debt consolidation. Home equity loans typically have much lower rates than other debts, which means you could pay less over time while rolling multiple debts into one fixed monthly payment. 

Additionally, you can borrow larger amounts if needed. Since there's no restriction on how to use the funds, you can tackle anything you want to—like high credit card balances, medical bills, or owed taxes. 

However, it's not a decision to take lightly. Since your home is on the line, missing payments could put it at risk. 

Pros of using a home equity to pay off debt

‍Lower interest rates

Since your property is used as collateral, the interest rates tend to be more favorable than personal loans and credit cards. In turn, this can save you hundreds—even thousands—in overall borrowing costs. 

Fixed rates

Unlike credit cards and HELOCs, 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.

Single loan payment

Managing multiple debts and various due dates can be daunting. Consolidating your balances into one payment will streamline the payoff process. This can also reduce the risk of a late or missed payment.

‍Ability to pay down debt faster

Lower rates tend to reduce the minimum monthly payment you're on the hook for. With more of your cash flow free each month, you can chip away at debt more quickly, should you choose.

Higher borrowing limits 

Home equity loans allow you to borrow more than personal loans or credit cards. So, if you need to accomplish more than just debt consolidation—like home repairs or medical expenses—you can leverage enough to cover your needs.

Cons of using a home equity loan to pay off debt

Upfront costs

You'll be on the hook for various fees and closing costs, ranging from 2% to 5% of the loan amount. Depending on how much debt you want to consolidate, it may be cheaper to explore other options. 

Longer repayment term

Unlike personal loans, which have a 1 to 7-year repayment period, home equity loans have a 10 to 30-year term. While spreading your debt over many years can reduce monthly payments, it can also increase the total interest paid. 

Market fluctuations

If your home value declines, you could potentially owe more than your home is worth. This can make a home sale or refinance challenging—unless you can cover the expenses out of pocket.

Reduced equity

Tapping into your equity for debt consolidation today may limit your ability to draw on it for future needs. Although having multiple home equity products on the same property is not impossible, it requires significant home value and equity.

Loss of federal protections

If the debt you are looking to repay involves federal student loans, refinancing will cause you to lose access to income-driven repayment plans, deferment, and loan forgiveness programs.

Risk of losing your home

Home equity loans are secured by your property, meaning defaulting on the loan can lead to foreclosure. 

Alternatives for debt consolidation

Home equity lines of credit (HELOC)

A HELOC provides a revolving line of credit that works similarly to a credit card. There are two phases—the draw and repayment period. During the 5 to 10-year draw period, you can use the line of credit as you need, making interest-only payments. Once the repayment period begins, the line closes, and you're responsible for the balance plus interest. 

Unlike home equity loans, HELOCs generally have variable interest rates, meaning payments can fluctuate. 

Home equity investments (HEI)

Home equity investments (HEI) are another way to tap into your home wealth for debt consolidation. You get a lump sum of cash in exchange for a share of your home's future appreciation. 

There are no monthly payments. Instead, you repay your investment through a home sale, refinance, or using another source of funds anytime during a flexible 30-year term.

HEIs have less stringent requirements than other equity products. You’ll need sufficient equity and a credit score above 500 to qualify—there are no income requirements. 

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 a new rate and terms.

If you have a high mortgage rate, this can be a particularly beneficial way to cut down on debt and reduce how much interest you'll pay over the life of your mortgage loan.

Frequently asked questions

Is it a good idea to use home equity to consolidate debt?

Using a home equity loan to consolidate debt can be a smart move if it helps you secure a lower interest rate and simplifies your payments. However, because your home is used as collateral, it's important to be confident in your ability to repay the loan.

What disqualifies you from a home equity loan?

You may be disqualified from a home equity loan if you have insufficient home equity (typically less than 15-20%), a low credit score (below 620), a high debt-to-income ratio, or unstable income. Additionally, if your home has a low appraised value or serious structural issues, a lender may consider it too great of a risk to allow borrowing.

What is the monthly payment on a $50,000 home equity loan?

The monthly payment on a $50,000 home equity loan will depend on the interest rate and loan term. For example, a loan with a 10-year term and 7% interest rate could cost approximately $580 monthly. A longer-term loan may lower your monthly payment, but you’ll pay more in interest over time. Here's a free home equity loan calculator to explore various scenarios. 

Final thoughts

A home equity loan can be a powerful tool for debt consolidation. However, it's important to weigh the benefits against the risks to determine if it's the right solution for your needs. When used responsibly, a home equity loan can provide a path to financial stability and long-term savings.

Tap into your home wealth to break free of debt using a Home Equity Investment from Point. No monthly payments, just possibilities. Learn more at Point.com/hei.