Using home equity to consolidate and pay off debt may help you lower the interest you pay, but you could lose your home to foreclosure if you fail to make your payments.
Using a home equity loan for debt consolidation will generally lower your monthly payments since you'll likely have a lower interest rate and a longer loan term. If you have a tight monthly budget, the money you save each month could be exactly what you need to get out of debt.
Having more equity in your home means a smaller monthly mortgage payment (versus having less equity), and therefore you are keeping more of your monthly salary for other uses, including saving for retirement. But also fun, vacations, groceries, etc.
Based on those repayment terms and rates, here's how much you can expect to pay each month on a $100,000 home equity loan: 10-year fixed home equity loan at 8.50%: $1,239.86 per month. 15-year fixed home equity loan at 8.41%: $979.47 per month.
Here's what a $25,000 home equity loan would cost with the average rates tied to those repayment terms: 10-year fixed home equity loan at 8.50%: $309.96 per month. 15-year fixed home equity loan at 8.41%: $244.87 per month.
While home loan interest rates overall have risen dramatically since 2022, HELOC rates still tend to be lower than those on credit cards and personal loans. If you qualify for the best rates, a HELOC can be a less expensive way to consolidate debt or finance a home renovation.
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Home equity loans use your home as collateral. You could lose your home if you can't keep up with your loan payments. Home equity loans should only be used to add to your home's value. If you've tapped too much equity and your home's value plummets, you could go underwater and be unable to move or sell your home.
Since Debt is almost always cheaper than Equity, Debt is almost always the answer. Debt is cheaper than Equity because interest paid on Debt is tax-deductible, and lenders' expected returns are lower than those of equity investors (shareholders). The risk and potential returns of Debt are both lower.
You should never take out a home equity loan to buy a car. Auto loan interest rates are often lower than home equity loan rates, so you'd actually be paying more to borrow money. Plus, an auto loan doesn't erode your home's equity or risk foreclosure if you can't pay it back.
A $50,000 home equity loan comes with payments between $489 and $620 per month now for qualified borrowers. However, there is an emphasis on qualified borrowers. If you don't have a good credit score and clean credit history you won't be offered the best rates and terms.
Equity release can be used for a variety of reasons. It's commonly used for home improvements, supplementing income or paying for long-term care. However it can be used to help you manage your debt or to repay a mortgage.
If you do it right, debt consolidation might slightly decrease your score temporarily. The drop will come from a hard inquiry that appears on your credit reports every time you apply for credit. But, according to Experian, the decrease is normally less than 5 points and your score should rebound within a few months.
A general rule of thumb to consider is that if your expected rate of return on investments is lower than the interest rate on your debt, you should pay down debt first. Historically, the stock market has returned an average of between 9% and 10% annually.
Any loan increases your debt burden and the demands on your income, of course. But by tapping into your home's equity, you're essentially depleting your ownership stake — transforming a valuable asset into a costly obligation. As your debt levels rise, so does your debt-to-income ratio (DTI).
Does a home equity loan require an appraisal? Yes. This is the case for home equity related financial products such as fixed rate home equity loans, home equity lines of credit (HELOCs), and cash out refinances.
HELOCs in particular can be a trap. “Many homeowners find it difficult to stay disciplined in paying down the principal on their line of credit,” Bellas says. During the initial draw period, “most HELOCs only require you to pay down the interest every month, similar to how a credit card has a minimum payment.
Homeowners can use a home equity loan for anything they like, but it's wise to avoid using equity to finance purchases that can't be recouped, like vacations. It's better to leverage your equity in ways that will help build your wealth, such as consolidating and paying down high-interest debt.
The interest on a home equity loan is tax-deductible, provided the funds were used to buy or build a home, or make improvements to one, as defined by the IRS.
In summary, the scenario in which most homeowners commonly use the equity in their homes is when they sell their current property to buy a new one. This enables them to leverage the accumulated equity as a down payment for the new home, providing flexibility and potential advantages in their housing transition.
Key Takeaways
In a true financial emergency, a HELOC can provide lower-interest cash than other sources, such as credit cards and personal loans. Using a HELOC to fund a vacation, buy a car, pay off credit card debt, pay for college, or invest in real estate is not a good idea.
Depending on which situation applies, lenders cannot issue them a home equity loan until they either earn additional equity in their home or pay off some of their existing debts. Another common issue you might run into is having a credit score or payment history not meeting a lender's requirement.
Typically, HELOCs will have lower interest rates and greater payment flexibility, but if you need all the money at once, a home equity loan is better.