Using a Home Equity Loan for Debt Consolidation Is Not Worth the Risk

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While high home prices aren’t great news for homebuyers, many existing homeowners are sitting on a goldmine of equity.

By the end of the second half of 2022, the average U.S. homeowner had $216,900 in “tappable equity” while still retaining 20%, according to the latest data provided by mortgage technology and data provider Black Knight. 

Given record-high equity and relatively low rates on HELOCs and home equity loans, it may be tempting to tap into your equity to consolidate and pay down other debts that have higher interest  — such as credit cards. Taking on a home equity loan or HELOC for debt payoff has its advantages, but it also comes with risks. Experts also suggest exploring alternatives before you use your home equity to consolidate debt. 

Pros and Cons of Using Your Home Equity for Debt Consolidation

If you have significant high-interest debt, using your home equity to pay it off will likely result in a lower interest rate. The average rate for a 10-year, $30,000 home equity loan currently sits at 7.05% The average credit card interest rate is 15%, but many times, consumers find themselves with even higher credit card interest rates surpassing 20% or 25%. Reducing the interest rate you pay on your debts will help you pay off balances faster since more of your payments will go towards the principal versus interest. 

Another advantage is to have one monthly payment, which could make it easier to manage your debt, especially if you have multiple loan payments. Home equity loans can come with terms as long as 30 years which could lower monthly payments. 

Despite these advantages, this strategy can be dangerous. While credit card debt is unsecured, meaning it doesn’t require collateral, both home equity loans and HELOCs use your home as collateral. 

Beyond putting your home at risk, you also won’t be able to deduct the interest on your HELOC or home equity loan on your taxes. When you borrow against your home and use the money to make improvements, the interest is generally tax-deductible. But if you use it for another purpose, it isn’t. 

Plus, you might need to pay closing costs when you tap into your home equity, which can amount to 2% to 5% of the loan amount. It may also take between two and six weeks for loan funds to be disbursed to you. 

Pros

  • Your interest rate will likely be lower

  • One monthly payment is simpler to manage

  • Your monthly debt payments could decrease

Cons

  • Your home is at risk

  • Interest probably won’t be tax deductible

  • You will likely pay some hefty fees

  • The timeframe for funding will be longer than some alternatives.

How to Get a Home Equity Loan or HELOC for Debt Consolidation

Many banks, credit unions, and online lenders offer home equity loans and HELOCs. Here’s how to get one:

  1. Decide if a home equity loan or HELOC makes more sense for your situation. For instance, if you know the exact amount you’d like to consolidate, a home equity loan could make sense. 
  2. Compare options from different lenders. Taking the time to shop around can help you find the best possible rates and terms. 
  3. Submit an application. Just as you did with your home mortgage, you’ll need to provide income and identity verification, proof of address, and documentation of your assets.
  4. Await an appraisal. Your lender will order an appraisal before approving you for a home equity loan or HELOC. 
  5. Close on the loan. It generally takes between two and six weeks to close on a home equity loan or HELOC.

Expert Take: Is Using Home Equity a Good or Bad Idea for Debt Consolidation?

Experts tend to agree, taking on new secured debt — with a house as collateral — to eliminate high-interest debt is not the best move. “It’s extremely rare that I’d say borrow from your house to resolve your credit card debt,” says Leslie Tayne, founder and head attorney at Tayne Law Group.

“I wouldn’t necessarily recommend turning unsecured debt or credit card debt into secured debt,” Tayne says. “You wouldn’t lose your home over credit card debt, but you might lose your home if you default on a HELOC.”

“Ideally, you want to take a look at your budget and consider different alternatives. If you don’t budget appropriately after you take a HELOC or home equity loan, you could easily be underwater again. And while you might get a lower interest rate than you would with credit cards, the upfront costs of tapping into your home equity are often high.” 

Alternatives to Using Home Equity to Consolidate Debt

For those struggling with high interest rates and juggling several monthly payments, an unsecured credit card or personal loan could be a better alternative for debt consolidation. 

Balance Transfer Credit Cards

Balance transfer credit cards often come with a promotional interest rate for a set period, like 12 or 18 months. During this time, you’ll benefit from a low or0% interest rate. This interest-free period could give you the time you need to pay off your existing debt without incurring high interest charges. Just be sure to repay your balance before the promotional period ends, as the card’s regular rate, which can be high, will apply afterward.

Unsecured Personal Loan

Another alternative is an unsecured personal loan. Personal loans typically have low fixed rates, and terms generally range from 12 to 60 months. Depending on your lender, you might be able to borrow up to $50,000, and funds are often disbursed as soon as one to two business days. 

Cash-Out Refinance

While mortgage rates have been creeping up, a cash-out refinance could still make sense if you’re looking to consolidate debt. Whether this option makes sense depends on several factors, including the amount of equity you have in your home, your credit, and the amount you want to borrow. 

With a cash-out refinance, you replace your existing mortgage loan with a larger mortgage loan, and the difference is disbursed to you as a lump sum. You could then use these funds to consolidate your debt. 

Experts generally don’t advise refinancing into a new mortgage loan with a higher interest rate than what you already have. For instance, if your current mortgage rate is 4%, a cash-out refinance rate today would be above 5.5% and wouldn’t be worth it in the long run. 

Negotiate With Your Creditors

Your creditors may also be willing to work with you to create a debt repayment plan that’s more manageable. “It’s possible to renegotiate the terms of outstanding credit card debt,” says William Bevins, CFP and fiduciary financial advisor in Tennessee. “Reducing the current interest rate, requesting a temporary payment reduction, and moving monthly payment due dates are a few possibilities.”

Frequently Asked Questions (FAQ)

Can I get approved for a HELOC or home equity loan if I already have a lot of debt?

It’s possible to get a HELOC or home equity loan if you have significant credit card debt. However, whether or not you’re approved will likely depend on how much equity you have in your home, your credit score, your income, and other factors. 

Is it smart to use equity to consolidate debt?

Using your home equity to consolidate debt can be a risky move. If you don’t stay on top of your monthly payments, your lender could foreclose on your home. A balance transfer credit card, personal loan, or another form of unsecured financing could be a less risky choice.