How to use a home equity loan for debt consolidation

The equity in your home could be the secret weapon to reducing your debt and saving money on interest

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A home equity loan can be an effective tool to pay off debt and save money on interest in the long run. Learn how to use one for debt consolidation. (iStock)

If you’re struggling with debt — such as a high-interest credit card balance — you could leverage the equity in your home via a home equity loan and use that to lower your monthly debt payments. Home equity loans typically have lower interest rates than credit cards, so they can be an effective tool for consolidating and reducing debt.

Home equity loans aren’t without drawbacks, though. Here’s what you need to know about using a home equity loan to pay off debt. 

While Credible doesn’t offer home equity loans, you can use Credible to compare mortgage refinance rates from multiple lenders. 

How to use a home equity loan for debt consolidation

A home equity loan is a second mortgage product that allows you to borrow against any equity you’ve built in your property. You’ll receive your funds as a lump-sum payment — similar to a personal loan. Then, each month, in addition to your regular monthly mortgage payment, you’ll also make a payment to repay your home equity loan. 

Say you take on a home equity loan in the amount of $50,000 at a fixed interest rate. You get the $50,000 and use it to pay off all outstanding credit card debts. Each month, in addition to your monthly mortgage payment, you also make a payment on the second mortgage loan of $50,000. Because the home equity loan has a fixed interest rate, you’ll pay the same amount each month for the life of the loan.

Pros of using a home equity loan to pay off credit card debt

Home equity loans come with many benefits, particularly if you’re looking to use one to get out of debt:  

  • Lower interest rates — In 2022, the average credit card interest rate hovers around 16%, according to data from the Federal Reserve, while home equity rates tend to be slightly higher than current mortgage rates.
  • Access to large funds — Depending on the equity you have in your home, home equity loans may provide access to a larger amount than a personal loan. If you need cash to pay for a large credit card bill, a home equity loan may be the better option for funding this expense in full.
  • Simplifies debt payments — With a home equity loan, you have a fixed interest rate and monthly payment. If you consolidate multiple cards (especially those with variable interest rates) into your home equity loan, you’ll only have to keep track of one payment each month.

Cons of using a home equity loan to pay off credit card debt

With any financial decision, you should consider the pros against any potential drawbacks, including:  

  • Using your home as collateral — Any time you use your home as collateral for a loan, you risk losing your home to foreclosure if you can’t keep up with payments.
  • Home value could drop — If you take out a home equity loan and your home’s value suddenly drops, you could end up underwater on your mortgage and owe more than your home is worth.
  • Doesn’t prevent new debt — Taking on home equity debt to pay off credit card debt can be tricky, particularly if you have chronic spending issues. If you don’t address the circumstances that caused your credit card debt, you run the risk of falling into deeper debt. 


How much can you borrow with a home equity loan?

Home equity loans are typically easy to obtain, especially if you have decent credit, but keep in mind that most lenders will only allow you to borrow up to a certain percentage of your home’s total equity — usually 80%.

Your home equity is the difference between the home’s appraised value and your current mortgage balance. For example, if your home’s appraised value is $400,000 and you have an outstanding mortgage balance of $250,000, you’d have $150,000 in home equity. In this scenario, you’d be able to borrow up to $120,000 in equity with a home equity loan, assuming your lender follows the 80% total equity limit. 

It varies by lender, but in order to qualify for a home equity loan, you typically must have:

  • At least 15% equity in your home
  • A minimum credit score of 620
  • A maximum debt-to-income (DTI) ratio of 43%

If the balance of a home equity loan sends you over the 43% DTI ratio threshold, for example, you’ll likely only be able to borrow up to whatever amount puts you at that limit.

With Credible, you can easily compare mortgage refinance options from various lenders.

Alternatives to a home equity loan for debt consolidation 

Depending on the type of debt and interest rate you have, you may be able to find an option that doesn’t require you to put up your house as collateral. Other options for paying off debt include: 

  • Debt consolidation loan — This is a type of personal loan that bundles your debt balances into one low-interest loan and one monthly payment.
  • Balance transfer credit card — A balance transfer credit card allows you to transfer over an existing balance to a card with 0% interest for a certain amount of time, usually 12 to 18 months. You’ll generally need good credit to qualify for one of these.
  • Cash-out refinance — With a cash-out refinance, you take out a completely new mortgage with a larger amount than your current balance. You’ll use that new mortgage to pay off your existing mortgage and receive the difference in cash, which you can use to pay off your debt. This allows you to access your equity without taking out a second mortgage. But it does use your home as collateral.
  • Personal loan — This is a low-interest loan that can be used for a variety of reasons, including paying off high-interest debt. Most are unsecured, so you don’t need to risk your home or other collateral to get a personal loan.
  • 401(k) loan — A 401(k) loan lets you borrow money against your 401(k) at an interest rate much lower than most credit cards. The interest you pay on the loan goes back into your retirement account. But if you fail to repay the loan as agreed, you could face tax consequences. Plans vary by employer, so be sure to find out what your plan allows.


How to pay off debt without a loan

You can also attempt to pay down your debt in other ways without incurring additional debt:

  • Create a budget. A strong budget can help you stay on track with spending and find additional funds to make extra debt payments.
  • Try a debt repayment strategy. The snowball method (paying off your smallest loans first) or avalanche method (paying off loans with the highest interest rates first) can help you tackle your debt more effectively.
  • Pay more than the minimum. Every extra payment above your minimum helps chip away at your debt over time, allowing you to pay less in interest.
  • Look for areas to cut back. While cutting back is never fun, reducing expenses also frees up more money for additional debt payments. 

Home equity loans come with lower interest rates because they’re secured by a significant piece of collateral — your home. While there are positives and drawbacks to this type of financial tool, ultimately home equity loans can prove useful if you find yourself in a tough financial position or simply desire to finance a major purchase at a lower interest rate than a credit card. 

If you’re thinking about a mortgage refinance, Credible lets you easily compare mortgage refinance rates from various lenders.