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Getting a home equity loan for debt consolidation might be a tempting option. After all, a second mortgage is a cheap way to borrow money compared to the average credit card.
But turning other types of debt into debt that’s secured by your home puts your home at risk — and that’s not the only downside of this option.
Here’s what you need to know if you’re considering a home equity loan for debt consolidation:
- How to consolidate debt with a home equity loan
- Pros of using a home equity loan for debt consolidation
- Cons of using a home equity loan for debt consolidation
- Who should consider consolidating debt with a home equity loan?
- Other options for debt consolidation
How to consolidate debt with a home equity loan
Home equity is the part of your home’s market value that you don’t have a mortgage on. If your home is worth $300,000 and your current mortgage balance is $100,000, you have $200,000 of home equity.
Homeowners often associate home equity loans with home improvements, but you can use the money however you want. For example, you might use the loan to pay off high-interest credit card debt, or any other debt, to improve your financial situation.
Qualifying for a home equity loan
While the specific requirements to get a home equity loan vary by lender, here’s a general idea of what they’ll look for:
- Credit score: Most lenders will want you to have a credit score of at least 680 to qualify for a home equity loan. You may need a higher score to get the lender’s best interest rate.
- Debt-to-income ratio (DTI): Your debt-to-income ratio is the percentage of your pre-tax income that goes toward your first mortgage and any other monthly debt payments that appear on your credit report. You’ll usually need a DTI ratio of 43% or less to get a home equity loan.
- Equity: Many lenders want you to still have 20% equity after taking out a second mortgage.
Pros of using a home equity loan for debt consolidation
The main draw of this approach to debt consolidation is that you could save a lot of money by replacing higher-interest debt with lower-interest debt.
- Lower interest rates: The average interest rate for credit card debt is about 16%, according to data from the Federal Reserve, while the typical interest rate for a home equity loan is just 3% to 5% for highly qualified borrowers. You could save $110 to $130 per year for every $1,000 of consolidated debt.
- Lower monthly payments: You could also enjoy more room in your budget each month to tackle goals you may have neglected due to your debt, like saving for retirement.
- A single monthly payment: Turning several monthly debt payments into a single payment may be more convenient and easier to keep track of.
Cons of using a home equity loan for debt consolidation
The main downsides of consolidating debt with a home equity loan are using your home as collateral and having to pay closing costs.
- Foreclosure risk: A home equity loan puts your home up as collateral, just like a first mortgage does. The extra debt could make you more vulnerable to foreclosure.
- Closing costs: You may have to pay closing costs such as origination fees, application fees, and recording fees, and these might amount to 2% to 5% of the loan amount. However, some lenders will pay your closing costs.
- More interest overall: Since it can take as long as 30 years to repay a home equity loan, you might pay more interest overall by consolidating your debt than by using a method like the debt snowball or debt avalanche to pay down your debts as quickly as possible.
- Increased debt risk: You might be tempted to keep charging things to the credit cards you pay off. This could put you in even more debt than you started with.
Who should consider consolidating debt with a home equity loan?
It’s a judgment call, but financial experts often say that consolidating debt with a home equity loan is generally not the best idea because of the cons mentioned above.
A possible exception is if the circumstances that caused you to get into high-interest debt were temporary and you’ve resolved the underlying problem.
Maybe you didn’t know better at the time but you’ve greatly increased your personal finance knowledge since then. Perhaps you were unemployed and had no other way to make ends meet, but now you have a stable job that pays well. If that’s the case, using home equity to consolidate debt might be a perfectly fine option.
Other options for debt consolidation
A home equity loan isn’t your only option for consolidating debt, though. You should also consider these alternatives and choose the one that’s best for your situation.
Home equity line of credit (HELOC)
A home equity line of credit is similar to a home equity loan in that it’s also a type of second mortgage with a fixed term, such as 20 years. The difference is that you don’t borrow a lump sum at a fixed rate.
Instead, you borrow smaller sums as you need them during the draw period, and pay a variable interest rate on what you borrow, much like a credit card. Some HELOCs have a fixed-rate option that lets you lock in the interest rate on what you borrowed.
|Lower rate than home equity loans||Rate is variable|
|Lender may pay your closing costs||Possible early closure fee|
|Borrow smaller sums as needed||Increased foreclosure risk|
A cash-out refinance differs from a home equity loan or HELOC in that it replaces your existing first mortgage with a larger new mortgage. It’s the ultimate way to repay all your debt with a single loan, but it also has risks.
|Lower rate than home equity loans||Restarts your mortgage term|
|Can decrease your mortgage rate||Higher closing costs due to larger loan amount|
|Large loan amount||May take longer to become debt free|
Be sure to shop around and compare rates with multiple lenders if you decide to go with a cash-out refinance. You can do this easily with Credible — and you’ll be able to see your prequalified rates in just a few minutes.
Debt management plan
You can create a debt management plan yourself or follow a program online. But, if you want extra help, there are companies that specialize in getting people out of debt through planning, accountability, credit counseling, and negotiating lower interest rates.
|Avoid taking on additional debt||You may pay a fee for the service|
|Reputable providers offer personalized advice and expertise||Irreputable providers can worsen people’s problems|
|Doesn’t require good credit||Continue paying high interest rates|
Unlike a credit card, personal loans (including debt consolidation loans) have a fixed interest rate and fixed repayment period.
These features can help you pay off credit card debt without increasing your foreclosure risk or taking decades to pay back what you owe. If your credit score is high, you may be able to get a lower your rate too.
|Fast, easy closing||Smaller loan amount|
|Can be unsecured debt||Higher interest rate|
|Shorter repayment period||Higher monthly payment|
Credible can help you find a great rate on a personal loan for debt consolidation. Here are Credible’s partners that offer these types of loans:
|Lender||Fixed rates||Loan amounts||Min. credit score||Loan terms (years)|
|9.95% - 35.99% APR||$2,000 to $35,000**||550||2, 3, 4, 5*|
|6.79% - 17.99% APR||$5,000 to $35,000||740||1, 2, 3, 4, 5|
|4.99% - 35.99% APR||$5,000 to $35,000||600||2, 3, 4, 5|
|6.99% - 24.99% APR||$2,500 to $35,000||660||3, 4, 5, 6, 7|
|7.99% - 29.99% APR||$10,000 to $50,000||Not disclosed by lender||2, 3, 4, 5|
|7.04% - 35.89% APR||$1,000 to $40,000||600||3, 5|
|15.49% - 35.99% APR||$2,000 to $36,500||580||2, 3, 4|
|2.49% - 19.99% APR||$5,000 to $100,000||660||2, 3, 4, 5, 6, 7
(up to 12 years for home improvement loans)
|6.99% - 19.99% APR1||$3,500 to $40,0002||660|
(TransUnion FICO®️ Score 9)
|3, 4, 5, 6, 7|
|18.00% - 35.99% APR||$1,500 to $20,000||None||2, 3, 4, 5|
|5.99% - 17.99% APR||$600 to $50,000 |
(depending on loan term)
|670||1, 2, 3, 4, 5|
|6.95% - 35.99% APR||$2,000 to $40,000||640||3, 5|
|5.99% - 18.83% APR||$5,000 to $100,000||Does not disclose||2, 3, 4, 5, 6, 7|
|8.93% - 35.93% APR7||$1,000 to $50,000||560||3 to 5 years 8|
|5.94% - 35.97% APR||$1,000 to $50,000||560||2, 3, 5, 6|
|6.46% - 35.99% APR4||$1,000 to $50,0005||580||3 to 5 years4|