To use a home equity loan for debt consolidation, first tally up the total amount of debt that needs to be consolidated, then take out a home equity loan for at least that amount, and use the money to pay off the original debts. This process will leave only one debt – the home equity loan – with one monthly payment. In other words, all of the other debts will be “consolidated” into the home equity loan.
Borrowers can use the money from a home equity loan for almost anything they want, including paying off or consolidating various types of debts – like balances from credit cards and personal loans. The main benefit of using a home equity loan for debt consolidation is the potential for low interest rates and high loan amounts. However, there are risks that come with the process, as home equity loans are secured by the borrower's house. That means it's possible for a borrower to lose their house if they're unable to pay back their loan.
You can also use a home equity line of credit for debt consolidation. A HELOC is almost like a home equity loan, except you borrow money up to a certain amount on demand, rather than getting a lump sum upfront. Typically, there is a draw period during which you can borrow money as many times as you want within the credit limit, and then a repayment period to pay off any remaining balance. These lines of credit are also secured by your house.
It's important to understand all the details of using a home equity loan or HELOC for debt consolidation before deciding to take one out.
Using a Home Equity Loan for Debt Consolidation:
- How home equity loans and HELOCs work: Home equity loans let you borrow money based on the value of your home, minus the amount left to pay on the mortgage. You receive a lump sum and pay it back in equal monthly installments. HELOCS don't give you a lump sum, but rather let you borrow up to a certain credit limit, and borrow multiple times, like a credit card.
- Why home equity loans are good for debt consolidation: Home equity loans and HELOCs tend to have very low interest rates, usually in the range of 4% to 8%. In addition, if you have a lot of equity in your home, you'll be able to borrow a lot of money. You'll typically have 5 to 30 years to pay off the loan, too.
- The dangers of home equity loans and HELOCs: Home equity loans and HELOCs are secured by your house. So if you default, meaning you are unable to pay back what you owe, the lender may be able to foreclose on your house to recoup their money. In contrast, if you use a personal loan or credit card for debt consolidation, there's typically no collateral.
While you can use a home equity loan for debt consolidation, it may not be the right idea in all cases. Home equity loans and HELOCs are best for financing big debts that you're confident you can pay back. If you want to minimize your risk, you may want to pursue other options.
Alternatives to a Home Equity Loan for Debt Consolidation
Personal loan. Unlike with a home equity loan or HELOC, you typically will not have to put up any collateral to get a personal loan. Personal loans also usually take fewer than seven business days to get, while home equity loans or HELOCs might take weeks. Personal loans are more expensive, though, with APRs ranging from 6% to 36%.
Credit card. Many credit cards offer introductory 0% APRs on balance transfers, making them good for consolidating debts interest-free for a limited time. However, you may not be able to get a big enough credit line on a credit card to accommodate your existing debts, and the 0% period will usually last only 6 to 24 months. Afterward, the card's regular APR is likely to be over 19%.