The Pros And Cons Of Using A Home Equity Loan For Debt Consolidation
6-Minute ReadUPDATED: April 14, 2023
If you’re struggling under the weight of credit card debt, unpaid bills or non-mortgage loans, taking out a home equity loan may be your best option to consolidate your debt. While this debt consolidation method is not for everyone, home equity loans provide lower interest rates and a tax deduction that can help overwhelmed borrowers get back on track.
Read on to learn the pros and cons of using a home equity loan for debt consolidation, as well as whether you should tap into your home’s equity.
The Basics Of Using A Home Equity Loan For Debt Consolidation
First things first: Let’s review the basics of home equity. Home equity represents the difference between how much your home is worth and how much you owe the mortgage lender.
This is one of any homeowners’ most valuable resources, because more home equity equals more access to cash, loans and lines of credit. For example, if your house is worth $200,000 but you owe $100,000 on the mortgage, you could potentially borrow $100,000 through a home equity loan.
Home equity loans are a type of secured loan that require borrowers to use their house as collateral. Borrowers can use home equity loans to pay off high-interest debts, such as credit cards and student loans, at a lower interest rate. So if you’re willing to tap into your home equity, you can use it to consolidate your debts into one monthly payment with a lower interest rate.
How Home Equity Loans Work For Debt Consolidation
When considering a home equity loan for debt consolidation, it’s helpful to think of it as a "second mortgage." Once the loan is approved, the lender will provide a lump sum payment that’s equal to the allotted percentage of your home equity. You can use the cash loan to make lower-interest payments on your consolidated debt.
From there, you’ll be responsible for making mortgage payments on the home equity loan in addition to your original mortgage payments. Keep in mind that the new repayment period is typically shorter than the first mortgage.
The Pros And Cons Of Home Equity Loans For Debt Consolidation
So, what are the benefits and drawbacks of using a home equity loan to consolidate debt? Let’s review the key ways in which this debt consolidation method could potentially help or harm borrowers.
Pros Of Home Equity Debt Consolidation
One Simple Payment
The primary benefit of any debt consolidation method is simplifying multiple monthly payments into one, streamlined payment. Paying down your debts through a monthly home equity loan payment decreases the likelihood of forgetting a payment.
Lower Interest Rate
As mentioned above, home equity loans provide lower interest rates because the funds are secured against the value of the borrower’s home. This benefit paves the way for borrowers to pay down their debts faster than if they were tied down by high interest rates.
Qualify With A Lower Credit Score
Since home equity loans are backed by the collateral of the borrower’s home, their credit score is less critical to the lender’s approval. Before applying, research the credit score requirements of your loan lender.
Another bonus of using a home equity loan for debt consolidation is that the loan’s interest can be tax deductible. When it comes to getting out of debt, every dollar counts!
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Cons Of Home Equity Debt Consolidation
Your House Is Collateral
The bottom line is that putting up your home’s equity as collateral for debt consolidation is incredibly risky. If you default on the home equity loan, you may face foreclosure on your home. Borrowers should seriously weigh this risk against their ability to make on-time payments before applying for a home equity loan.
Extension Of The Debt Payoff Timeline
Since you’ll have to pay off the home equity loan faster than the original mortgage, it may extend your loan payoff timeline. Plus, if the spending problems that led to debt consolidation continue, you’ll be piling new debts on top of old ones.
Risk Of Negative Equity
Negative equity is when you owe more to the mortgage lender than the house is worth. Since home equity loans are based on the value of the home, any decrease to the home’s worth could cause the borrower to go "underwater" on both the house and the loan.
Alternative Debt Consolidation Methods To Consider
By now, we’ve established that while there are benefits to using home equity loans for debt consolidation, there are some serious risks involved, too. Luckily, there are several other debt consolidation methods that have proven to be equally – if not more – effective.
Debt Consolidation Loans
It’s right there in the name. Debt consolidation loans are a type of personal loan that allows borrowers to take out a new loan to pay off multiple unsecured loans, such as credit cards, student loans or other non-mortgage loans.
Instead of requiring borrowers to put down collateral, debt consolidation loans provide funding based on their credit and financial history. Borrowers can apply for this type of loan through banks, credit unions and online options, including Rocket LoansⓇ, which could approve and fund the loan as soon as the same day.
Cash-out refinance is another popular tool for debt consolidation because it’s based on your original mortgage, which means that you’ll receive the lowest mortgage rate available for your financial status.
In comparison to using a home equity loan for debt consolidation, this option is less risky and provides better interest rates. With cash-out refinance, borrowers can work toward becoming debt-free without taking out the equivalent of a second mortgage. You can apply for a cash-out refinance online today through our trusted sister company, Rocket Mortgage®.
Balance Transfer Credit Card
Another solid option for consolidating debt is to apply for a balance transfer credit card. A balance transfer credit card allows you to move multiple outstanding debts to a credit card with a lower interest rate. Almost every credit card company grants balance transfers, and most extend low-interest introductory or 0% APR offers to borrowers with satisfactory credit.
The key to balance transfer credit cards is to pay off the majority of the total balance before the promotional period ends and the interest rates increase. Don’t forget to account for the card’s balance transfer fees, which can run up to 5% of the amount transferred.
Should I Get A Home Equity Loan For Debt Consolidation?
Like most financial products, the short answer is: Maybe. As discussed throughout this article, home equity is one of homeowners’ greatest assets, so it should be spent with great caution. In fact, some experts recommend only tapping into home equity for emergency expenses.
However, accruing a significant amount of high-interest debt could qualify as an emergency situation. Before using your home equity to consolidate your debt, consider how this decision will affect future financial aspirations, as well as whether this is the right debt consolidation method for you.
At the end of the day, only you can decide whether a home equity loan is the right solution for your debt problem.
If you’re interested in consolidating your debts, there are several different options to consider. Evaluate the above risks, benefits and criteria when deciding whether a home equity loan is the right debt consolidation method for you.
And if not, take a look at less-risky options, such as debt consolidation loans or cash-out refinancing. And when you’re ready to take the first step toward buttoning up your credit and achieving more, apply for a Rocket Loans debt consolidation loan today.
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