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A home equity loan can be an effective tool for paying off debt and saving money on long-term interest. Learn how to use one for debt consolidation. (iStock)
If you’re struggling with debt, like a high-interest credit card balance, you can leverage the equity in your home through a home equity loan and use it to lower your monthly payments. Home equity loans generally have lower interest rates than credit cards, so they can be an effective tool for consolidating and reducing debt.
Home equity loans are not without drawbacks, however. Here’s what you need to know about using a home equity loan to pay off debt.
Although Credible does not 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
Suppose you take out a home equity loan for $50,000 at a fixed interest rate. You get the $50,000 and use it to pay off all outstanding credit card debt. Each month, in addition to your monthly mortgage payment, you also make a payment on the second mortgage of $50,000. Since the home equity loan has a fixed interest rate, you will pay the same amount each month for the duration of the loan.
Benefits of using a home equity loan to pay off credit card debt
Home equity loans have many advantages, especially 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 Federal Reserve data, while rates on home equity tend to be slightly higher than current mortgage rates.
- Access to significant funds — Depending on the equity in your home, home equity loans may provide access to a higher amount than a personal loan. If you need cash to pay a big credit card bill, a home equity loan may be the best option to fully fund that expense.
- Simplifies the payment of debts — With a home equity loan, you have a fixed interest rate and a monthly payment. If you’re consolidating multiple cards (especially those with variable interest rates) into your home loan, you’ll only have to track one payment per month.
Disadvantages of Using a Home Equity Loan to Pay Off Credit Card Debt
When making any financial decision, you need to consider the pros against the potential cons, including:
- Using your home as collateral — Whenever you use your home as collateral for a loan, you risk losing your home to foreclosure if you cannot meet the payments.
- The value of the house could drop — If you take out a home equity loan and the value of your home suddenly drops, you could find yourself underwater on your mortgage and owing more than your home is worth.
- Does not prevent new debts — Going into debt on home equity to pay off credit card debt can be tricky, especially if you have chronic spending issues. If you don’t address the circumstances that caused your credit card debt, you run the risk of getting into more debt.
IS INTEREST ON A HELOC DEDUCTIBLE?
How much can you borrow with a home loan?
Home equity loans are usually easy to get, 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 total equity. of your home, usually 80%.
This varies by lender, but to qualify for a home equity loan, you generally need to have:
- At least 15% equity in your home
- A minimum credit score of 620
- A maximum debt-to-income ratio (DTI) of 43%
If a home equity loan balance puts you over the DTI threshold of 43%, for example, you’ll likely only be able to borrow up to the amount that puts you at that limit.
With Credible, you can easily compare mortgage refinance options from various lenders.
Alternatives to a home loan for debt consolidation
Depending on the type of debt and the interest rate you have, you may be able to find an option that doesn’t require you to pledge your home. Other options for paying off debt include:
- debt consolidation loan — This is a type of personal loan that consolidates 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 an existing balance to a card at 0% interest for a certain period of time, usually 12 to 18 months. You’ll usually need good credit to qualify for one.
- Refinancing by collection – With a cash-in refinance, you take out a brand new mortgage for more than your current balance. You will use this 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 capital without taking out a second mortgage. But he’s using your house 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 from your 401(k) at a much lower interest rate 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 REFINANCE A HOME EQUITY LOAN
How to pay off debt without a loan
You can also try to pay off your debt in other ways without incurring additional debt:
- Create a budget. A solid budget can help you stay on track with your spending and find extra funds to pay off extra debt.
- Try a debt repayment strategy. The snowball method (paying off your smaller loans first) or the avalanche method (paying off the highest interest rate loans first) can help you manage your debt more effectively.
- Pay more than the minimum. Each additional payment above your minimum helps reduce your debt over time, allowing you to pay less interest.
- Look for areas to reduce. While it’s never fun to cut back on spending, cutting spending also frees up more money for paying off additional debt.
Home equity loans come with lower interest rates because they are secured by one important collateral: your home. Although there are advantages and disadvantages to this type of financial tool, home equity loans can be useful if you find yourself in a difficult financial situation or if you simply want to finance a major purchase at a low rate. lower interest than a credit card.
If you’re considering a mortgage refinance, Credible makes it easy to compare mortgage refinance rates from various lenders.