Home Equity Loan for Debt Consolidation

A home equity loan allows you to borrow money against your home – and is often referred to as a second mortgage. Although there can be advantages of using a home equity loan it does come with its potential risks, including the loss of your home.

Before considering taking out a loan and using the value of your home as collateral, it is important to read up on all of the benefits and risks associated with this type of loan before proceeding.^[1]

What is a home equity loan and how does it work?

A home equity loan (sometimes called a HEL) allows you to borrow money using the equity you have in your home as collateral. Home equity is the amount of your home that you own outright, which can be calculated by the difference between your current property value and the remaining balance on your mortgage.^{[2] [3]}

Lenders typically require you to have at least 15% to 20% equity to qualify – for example, if your home is worth $200,000 and you owe $160,000 on the mortgage, you have $40,000 (20%) in home equity. However, it’s important to note that home equity can change over time. If your property value decreases, due to changes in the local housing market , your available equity may also decline, even if your mortgage balance stays the same.^[4]

Home equity loans usually have fixed interest rates that will never change, and you will receive the money as a lump sum. Failing to repay the lender could result in the foreclosure of your home.^[3]

There are two types of home equity borrowing options, home equity loans and home equity lines of credit (HELOC). A home equity loan provides a lump sum upfront, while a HELOC lets you borrow as needed up to a set limit. Both may carry either a fixed or adjustable interest rate.^[5]

Can you use a home equity loan for debt consolidation?

Yes, a home equity loan can be used for debt consolidation. This allows you to borrow against your home equity and receive a lump sum to pay off existing debts such as credit cards, personal loans, or medical bills.

Home equity loans are a type of secured debt, meaning your home is collateral. Because of this, they may offer lower interest rates compared to unsecured loans like credit cards or personal loans.

Consolidating debts using a home equity loan could offer you lower interest rates compared to other lending options. This is because your home is used as collateral and allows you the chance to pay off higher-interest-rate debts with a lower-rate home equity loan.^[6]

Pros and cons of using a home equity loan for debt consolidation

Pros

• Consolidating debt: Consolidating your debts with a home equity loan could streamline your payments. Making one payment instead of several may make it easier to manage your payments.
• Fixed interest rates: You may be able to get a variable rate but typically these are fixed rate loans. Having fixed rates means that you won’t need to worry about fluctuating interest rates – if rates go up, you’ll already be locked into a fixed rate that will not change.
• Predictable payments: Having fixed interest rates also means predictable payments, allowing for easy budgeting and being able to predict your costs long-term.
• Lower interest rates: Compared to personal loans, home equity loans typically offer lower interest rates due to the loan being secured by your home (using your home as collateral), meaning that you may get better interest rates than you would on unsecured debt (credit cards and personal loans).
  ^{[6] [7] [8]}

Cons

• Limited borrowing flexibility: You can’t borrow additional funds from a home equity loan without applying for a new loan. In contrast, a HELOC allows you to make multiple withdrawals up to your credit limit during the draw period.
• Closing costs: Costs typically range from 2% to 5% of the loan amount, though some lenders may offer lower-cost options depending on the loan type and terms.
• Risk of losing your home: Using your home as collateral puts you at risk of losing your home if you default on your loan.
• Increased debt: While a home equity loan can consolidate debt, it is only useful if you limit the spending that caused the debt in the first place. You could be at risk of charging your credit cards again, making your debt worse with the addition of a home equity loan. It is important to address the root cause of your debt before taking out a loan.
  ^{[9] [10]}

How to qualify for a home equity loan

When applying for a home equity loan, it’s likely that they will take your financial history, income and debt-to-income (DTI) ratio into account. Here’s what may be required to qualify:

• Own 15-20% equity in your home.^[2]
• A DTI ideally below 43% – your debt-to-income ratio measures how much of your gross monthly income goes towards debt payment.^[6]
• Some lenders may require a FICO® score of 680 to qualify for a home equity loan. A higher credit score may improve your chances of approval and help you secure more favorable terms.^[2]

What to consider before consolidating debt with a home equity loan

Before considering a home equity loan, it may be worth ensuring that finances are stable, you have good financial habits, have a plan in place to pay down debt, and that you will avoid building up new debt.^[6]

Alternatives to using home equity loans for debt consolidation

There are alternative options to home equity loans when consolidating your debt, including personal loans, credit card refinancing, or a debt settlement program.

If your credit score is high enough, you could qualify for a personal loan. The loan could carry a lower interest rate, and collateral is not usually required, meaning that you won’t be risking your home to consolidate your debts. New loans could include origination and these fees could add to your costs.

Another option is to use credit card refinancing with a balance transfer. Though, an excellent credit score is more favorable to qualify for this option. This method involves moving debt from a card with a high APR to a card with a lower one. You may qualify for an interest-free grace period for 12 to 18 months. However, interest rates may increase significantly after the introductory period.^[1]

Frequently asked questions

Can I use a home equity loan to pay off student loans?

Similar to paying off other debts using a home equity loan, you may get benefits such as lower interest rates and a fixed rate option. However, if you use it to pay off federal student loans, this could forfeit your right to federal forgiveness opportunities.^[7]

What loan amount can you get from a home equity loan?

Lenders generally limit the amount you can borrow to between 60%-85% of your total equity, although some may lend more. You’d receive the amount in a lump-sum payment and make equal repayments on a monthly basis, with the term ranging from five to 30 years.^[2]

Can you use a home equity loan for debt consolidation with bad credit?

If you’re considering a home equity loan to pay off debts, you may wish to explore alternatives with a credit counselor that do not put your home at risk of foreclosure. Home equity loans may have upfront fees and costs, and it’s important to include those alongside your monthly payments when looking at your options.

It may be possible to qualify for a home equity loan with a lower credit score, but many lenders prefer a FICO® score of at least 680, and some may require 720 or higher to secure improved terms.^[2]

Sources

1. Debt.org. "Home Equity Loan Consolidation," https://www.debt.org/consolidation/home-equity-loan/.
2. Experian. "Requirements for Home Equity Loans and HELOCs," https://www.experian.com/blogs/ask-experian/requirements-for-home-equity-loans-and-helocs/.
3. Consumer Financial Protection Bureau. "What is a home equity loan?" https://www.consumerfinance.gov/ask-cfpb/what-is-a-home-equity-loan-en-106/.
4. Rocket Mortgage. "Home Equity: What It Is and How to Use It," https://www.rocketmortgage.com/learn/home-equity.
5. Consumer Financial Protection Bureau. "What is the difference between a home equity loan and a home equity line of credit (HELOC)?" https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-a-home-equity-loan-and-a-home-equity-line-of-credit-heloc-en-247/.
6. Navy Federal Credit Union. "Home Equity Loan for Debt Consolidation," https://www.navyfederal.org/makingcents/credit-debt/home-equity-loan-for-debt-consolidation.html.
7. Citizens Bank. "Home Equity and Student Loans," https://www.citizensbank.com/learning/home-equity-and-student-loans.aspx.
8. Experian. "Pros and Cons of Home Equity Loans," https://www.experian.com/blogs/ask-experian/pros-and-cons-home-equity-loan/.
9. Experian. "Home Equity Loan vs. Home Equity Line of Credit," https://www.experian.com/blogs/ask-experian/home-equity-loan-vs-home-equity-line-of-credit/.
10. Bankrate. "Using home equity to consolidate debt," https://www.bankrate.com/home-equity/use-home-equity-to-consolidate-debt/#why-use-home-equity.

About the author

Becca has over 10 years of experience as a content writer, working across various industries including finance, digital marketing, education, travel, and technology. Her work has been featured in publications including Forbes, Business Insider, AOL, Yahoo, GOBankingRates, and more.

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