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Using Home Equity Loan to Pay Off Debt

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Summary

Homeowners use home equity loans to consolidate and pay off high-interest debts.

  • Interest Rates: Rates are currently below 9%, significantly lower than credit card or personal loan rates.
  • Risk: Defaulting on the loan risks home foreclosure.
  • Loan Amount: Based on home equity, typically 80-95% of home’s value.
  • Savings Potential: Can significantly lower monthly payments and total interest paid.
  • Eligibility: Requires a minimum 640 credit score, stable income, and acceptable property conditions.

Of the hundreds of home equity posts we’ve written so far, this one is one of our favorites because it’s the core of what we do at House Numbers — we help homeowners pay off debt using their home equity. Although this method of debt consolidation is not for everyone, if you can afford the additional payments then using your home equity to consolidate debt could save you thousands in interest payments.

Home equity loans carry some of the lowest interest rates available compared to other personal loan options. Currently (early 2024), many lenders are offering home equity loans with rates below 9%. If you can get approved for one, you can use it to save money to consolidate debt and pay off other higher interest-rate debt. Credit cards and personal loans, for instance, can carry rates as high as 30% to 40% or more.

It doesn’t come without its warnings though. If you consolidate your debt but unable to meet your new second mortgage payments then you risk losing your home. Keep reading to learn more about these risks.

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Can you use a home equity loan to pay off debt?

With funds from a home equity loan, you can do a debt consolidation of high-interest-rate debt.

How it works

When you get a home equity loan, a lender deposits funds into your bank account. You can use those funds to pay off high-interest debt that you might have on personal loans.

The amount you can get is largely based on the equity you have in your home and how much you request. You can calculate this by taking the value of the property and subtracting the balance of all liens such as mortgage loans. 

Lenders rarely give you access to the full amount of home equity you have. Rather, many will issue a home equity loan between 80% and 95% of your home’s value. Below is an example of how this might work:

Home value$1,000,000
First mortgage loan balance$600,000
Equity in home$400,000 ($1,000,000 – $600,000)
Maximum loan-to-value (can vary per lender guidelines)90% of home value
Maximum home equity per LTV$1,000,000 x 90% = $900,000
Maximum home equity loan amount with 1st mortgage balance accounted for$300,000 ($900,000 minus $600,000 1st mortgage loan balance)

Who should consider paying off debt with a home equity loan?

You should consider home equity loan for debt consolidation if you currently have a lot of high-interest debt. Using a home equity loan for debt consolidation can lower your monthly payment amounts since they tend to have longer repayment periods compared to other types of consumer loans. Debt consolidation can also help by lowering your interest rate, which can help reduce the amount of interest fees you’ll end up paying over the life of the loan. 

To give you an idea of how much money you could save by using a home equity loan for debt consolidation, below is a list of average interest rates for different types of loans. Keep in mind that interest rates can vary based on the strength of your loan application such as your credit score and finances.  

  • Home equity loan: 8.98% to 9.08% as reported by Bankrate on January 3, 2024
  • Home equity line of credit (HELOC): 10.16% as reported by Bankrate on January 3, 2024
  • Auto loan (new vehicles): 5.07% to 14.18%, according to MarketWatch
  • Auto loan (used vehicles): 7.09% to 21.38%, according to MarketWatch
  • Personal loan: 10.73% to 32.00% according to Bankrate
  • Credit cards: As high as 29.43%, as reported by LendingTree

Risks

If you use a home equity loan for debt consolidation, one of the biggest risks you’ll face is that you might lose your home in foreclosure if you can no longer afford the monthly payment amounts. Just like with your primary mortgage, getting a home equity loan means you must agree to let the lender place a lien on your home. This lien will appear on any title searches for your home and serve as a notice to others that your property is being used as collateral for a loan. 

Foreclosure timelines can vary by geographic location, but you won’t typically be in danger of this until you’re at least 120 days late on your mortgage payment. If you are having difficulty making payments, notifying the lender can work to your advantage as it’s not uncommon for lenders to agree to modify your loan to reduce your loan payments to avoid foreclosure

Another risk is that you could also end up paying more in interest charges. This can happen because the repayment period on home equity loans can be as long as 30 years. If one of your main goals in paying off debt with a home equity loan is to save on interest fees, make sure you pay more than the minimum monthly payments. 

How much money can I save by using a home equity loan to pay off debt?

The example below illustrates how much money you can save by using a home equity loan to pay off debt. The figures used are based on average debt figures and interest rates as reported by LendingTree.

As you can see in the example below, an average consumer with just several types of debt could have monthly payments totaling $1,623 and end up paying $22,693 in interest charges. Using a home equity loan to pay off that debt would result in lower monthly payments, as well as the possibility of reducing the total interest paid. 

Loan Balance & Interest RateRepayment TermMonthly PaymentInterest Charges Over Life of Loan
Credit card debt $6,993 @ 22.77% interest Revolving $350 $1,882
Auto loan debt$40,184 @ 14% interest 67 months$868$17,953
Other personal consumer debt$11,692 @ 14.80%36 months$405$2,858
Total $58,869$1,623$22,693

Debt Consolidation Scenarios

Loan Balance & Interest RateRepayment TermMonthly PaymentInterest Charges Over Life of Loan
Home equity loan with 5-year payoff$58,869 @ 9%5 years$1,222$14,452
Home equity loan with 10-year payoff$58,869 @ 9%10 years$746$30,618
Home equity loan with 30-year payoff$58,869 @ 9%30 years$473$111,653

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Home equity loan to pay off credit card debt

What are the main benefits of paying off credit card debt?

Credit cards can be some of the most expensive types of debt you can have. This is because you can end up making payments indefinitely if you’re not careful. Credit cards often don’t have a set loan term and because they’re a revolving form of credit, you can continue adding to the balance before it’s fully paid off. 

Credit cards can also indirectly affect what you pay on other debt you have. If you’re using a high percentage of your credit limit, your credit score may drop. This in turn can negatively impact the interest rates you get on any new loans.

Should you close credit cards once they’re paid off?

If you use a home equity loan to pay off credit cards, consider whether you want to keep them open. We recommend keeping the cards open if they don’t have an annual fee because it can help the age of your credit history, something that has a positive impact on your credit score. If you decide to close the account, make sure you get written confirmation from the bank and that the account balance is $0. 

What are the requirements to get a home equity loan to pay off debt?

A home equity loan is a type of second mortgage that requires you to meet a lender’s eligibility criteria. This varies depending on the lender you choose but commonly includes a review of your credit, income, assets, and property characteristics. 

Credit & credit score

Most lenders will require a credit score of at least 640 for a home equity loan. Meeting the minimum requirement won’t guarantee approval, however, as other aspects of your credit will also be reviewed. Things like the amount of debt you’re carrying, the number and severity of late payments, and recent applications for credit can affect your approval odds. 

Income & employment

Lenders will calculate your debt-to-income (DTI) ratio by reviewing your income and debt levels. Most lenders require a 45% DTI or lower, but we have some tips on how to lower your DTI. Your employment history will also be reviewed to determine its stability, and you’ll typically need a two-year history in the same line of work to be eligible. 

Assets

Although uncommon, some lenders may require proof of sufficient assets as reserves. This is meant to provide the lender with assurance that you can continue making payments for a short time period if your income is temporarily interrupted. Eligible assets often include funds held in a checking, savings, mutual fund, stock, or retirement account. 

Property characteristics

Since home equity loans use your property as collateral, lenders will need to verify it is of sufficient value and in acceptable condition. This is often done with a home appraisal inspection, and you can check out our tips to ensure you have a favorable appraisal review. Home equity loans typically have a maximum 95% loan-to-value (LTV) ratio, which can be determined based on the equity you have in your home. The property must also be free of any health or safety hazards. 

What are some tips on how to get a home equity loan?

To ensure a smooth process when getting a home equity loan, you can first consider your qualifications and the strength of your application. You can also prepare documentation ahead of time prior to shopping interest rates with lenders. 

1. Consider your qualifications for a home equity loan

While the exact qualification requirements will vary from lender to lender, knowing the strength of your application can help you determine how difficult it will be to get approved. If you don’t have particularly strong qualifications, you may want to proactively consider seeking alternative financing options depending on how quickly you need funds. 

2. Gather commonly requested documents

Regardless of which lender you choose, many will require similar documentation to verify your eligibility. Gathering these items before you apply can save time and help in expediting the loan approval process so that you can consolidate debt more quickly.  

Commonly required documents include:

  • Pay stubs
  • Personal and business tax returns, if applicable
  • W-2 and/or 1099 tax forms
  • Bank statements
  • Loan statements or Notes for recently obtained debt

3. Shop rates with multiple lenders & apply

To improve your odds of getting a loan with the lowest rates and fees, we recommend getting quotes from several different lenders. In some cases, certain lenders may offer a lower introductory rate to attract new customers. Consider getting quotes from different types of lenders such as credit unions, banks, online lenders, and business loan brokers. 

Should I get a home equity loan to pay off credit card debt? 

By using a home equity loan to pay off credit card debt or other debt consolidation, you can save money on interest charges in the long run. Accessing your home’s equity can also help you get out of the debt cycle because you could end up making credit card payments indefinitely if you mismanage your personal finances. It doesn’t come without its risks, however, as you’ll need to pay closing costs and agree to use your home as collateral for the loan.

Using Home Equity Loan to Pay Off Debt

If you’re looking for ways to use your home equity to consolidate debt and get a better handle on your personal finances, you can use the services offered here at House Numbers, where we help you pay down your debt and find which debts should be paid first. We can also help you figure out the best ways to access your home equity and how much you can afford to get. These services are offered at no cost to you and with no impact on your credit score.  

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Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. All information shown here is for illustrative purpose only and the author is not making a recommendation of any particular product over another. All views and opinions expressed in this post belong to the author.

Andrew Wan

Written By Andrew Wan

With a decade of experience as a mortgage underwriter and a licensed California real estate broker since 2018, Andrew Wan use his expertise and experience to share insights on the housing industry. He covers a wide variety of topics, from buying a home to what the home loan process entails, and enjoy sharing tips to help better prepare you for how to make it all a seamless experience.