As you make payments on your home loan, the principal balance of your mortgage falls. This change in the difference between what you owe and what the house is worth essentially represents your personal financial interest in the home, which is also referred to as your equity.
While some homeowners choose to continue building equity until they own their home free and clear, others take out equity loans to extract that value and use it for home improvements, big-ticket purchases and even debt consolidation.
If you’ve been looking for a way to consolidate your debt, potentially reduce your interest payments, and make paying bills easier each month, it’s possible that an equity loan for debt consolidation is a good choice for you.
5 steps to consolidating debt with a home equity loan
With Americans paying $110 billion in fees and interest on credit card debts in 2018 — according to a MagnifyMoney analysis of Federal Deposit Insurance Corp. data — it comes as no surprise to hear that more than 50% of consumers with credit card debt exceeding $6,000 have consolidated their debt. In doing so, many of them have lowered their costs and made paying monthly bills easier. (Disclosure: MagnifyMoney, like Student Loan Hero, is owned by LendingTree.)
It may sound like a no-brainer, but putting your home on the line to pay off credit card and other consumer debt isn’t something you should do without careful consideration. Review this five-step guide for consolidating debt with a home equity loan to see if making this move offers you the right strategic advantage.
Decide if you should consolidate debt using home equity
Debt consolidation through a home equity loan isn’t something every homeowner should do. In some cases, it might be better to explore other alternatives, which we’ll discuss later. To help determine whether you’re a good fit for this solution, here are some of the pros and cons.
- You will have fewer bills
- You may get a lower interest rate
- Lower interest rates also mean lower payments
- Having a lump sum to pay creditors can give you negotiating power
- If you can’t afford to pay the loan, the bank could foreclose on your home
- You may be paying off the debt much longer
- Closing costs, appraisal fees and other expenses may make the loan more expensive than the credit card interest
- You still need to work on financial discipline and avoid repeating mistakes
- You may not have enough equity to consolidate all your debt
Once you’ve decided to take out a home equity loan for debt consolidation, get started by comparing rate offers from different lenders. Depending on your credit score, the lender’s rates, the fees and the payment term, you may find that a home equity loan offers little in the way of actual savings on your debt, which will mean you need to re-evaluate the decision. Even if you end up with a lower interest rate, if you choose a long loan repayment term, the consolidation could end up costing you more in interest than you otherwise would have paid.
Choose a lender
When choosing a lender, rates, fees and terms may be the most important criteria you evaluate, but you also want to consider the ease of working with a particular company. Does it offer a true digital lending experience? Does it have branches you can visit? Do you have a single contact for phone calls? Think about what’s important to you and make sure the lender you choose meets those expectations.
Plan to avoid future debts
An equity loan may help you consolidate debt and reduce interest, but it doesn’t mean that you won’t make the same mistakes again and rack up more debt — this time without any home equity left to save you. That’s why you also need to review your overall budget to make sure you stop overspending and relying on credit cards to ensure that the consolidation loan accomplishes what you intended and you don’t repeat your mistakes. It also may be a good idea to stop using credit cards completely so that you don’t defeat the consolidation loan’s purpose of giving you a single monthly bill to pay.
Make an emergency plan
Not everything in life goes according to plan. Job losses, layoffs, medical expenses and other financial catastrophes can play a role in whether you can keep up with equity loan payments, despite your best intentions. Contributing to an emergency fund can go a long way to making sure you can still make payments even when times get tough.
Taking all the pros and cons into consideration, you can see that a good fit for a home equity loan for debt consolidation is someone who can get a low-rate, low-fee loan. It is also someone who has a long-term plan in place to pay off the loan consistently and ensure they don’t repeat any past financial mistakes that drive up their debt again.
Alternative ways to consolidate debt
A home equity loan is not the only way to consolidate debt. Before you commit, you may also want to explore these (or other) alternatives.
Unsecured personal loans have no underlying collateral to collect if payments aren’t made. They can help consolidate debt without the risk of foreclosure on your home.
- Can be issued to those with no equity
- Can be issued faster than equity loans
- May have higher interest rates than equity loans
- May have restrictions on uses
Some credit cards offer incentives to new customers, including low- or no-interest balance transfers for a set period.
- Can remove interest for a limited period
- May have no balance transfer fee
- Preserves home equity for future uses
- May not be available to those with lower credit scores
- Interest can be high once the introductory period is over
- Credit limits may be too low
Chapter 13 bankruptcy
Another way to consolidate debt and potentially reduce overall debt payments is through Chapter 13 bankruptcy. Through this bankruptcy method, a filer creates a three- to five-year debt repayment plan based on what they can afford, which is determined by their income and state median expense statistics.
- Offers a short time to pay off debt
- Can reduce the total amount of some debts
- Stops collection activities
- Not all debts can be discharged
- May not be able to get new credit during the payment period
- Can impact credit score and appear on credit report for seven years
Use your savings
If you have savings, it may be worthwhile to consider using those funds to pay off your debts, especially if the interest rate you’re earning is less than the interest you’re paying on the debts. But if the savings are in a retirement account, potential taxes, investment losses and early withdrawal fees might make the move more expensive than it’s worth.
- Removes the old debt without incurring new debt
- Frees up monthly debt repayments so you can save money faster
- May leave you without funds for an emergency
- Could result in fees and taxes, depending on the type of savings account
Interested in a personal loan?Here are the top personal loan lenders of 2019!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.95% to 35.89%*. The origination fee ranges from 1% to 6% of the original principal balance and is deducted from your loan proceeds. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at the time of application. The average origination fee is 5.49% as of Q1 2017. In Georgia, the minimum loan amount is $3,025. In Massachusetts, the minimum loan amount is $6,025 if your APR is greater than 12%. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months. Borrower must be a U.S. citizen, permanent resident or be in the United States on a valid long term visa and at least 18 years old. Valid bank account and Social Security number are required. Equal Housing Lender. All loans are subject to credit approval. LendingClub’s physical address is: LendingClub, 71 Stevenson Street, Suite 1000, San Francisco, CA 94105.
†Per reviews collected and authenticated by Bazaarvoice in compliance with the Bazaarvoice Authentication Requirements, supported by anti-fraud technology and human analysis. All reviews can be reviewed at reviews.lendingclub.com
**Based on approximately 60% of borrowers who received offers through LendingClub’s marketing partners between January 1, 2018 to July 20,2018. The time it will take to fund your loan may vary.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|5.74% – 16.99%1||$5,000 - $100,000|
|7.54% – 35.99%||$1,000 - $50,000|
|7.99% – 35.89%*||$1,000 - $50,000|
|5.99% – 24.99%2||$5,000 - $35,000|
|5.99% – 29.99%3||$7,500 - $40,000|
|6.79% – 20.89%4||$5,000 - $50,000|
|9.99% – 35.99%5||$2,000 - $25,000|
|6.95% – 35.89%6||$1,000 - $40,000|
|6.99% – 18.24%7||$5,000 - $75,000|
|9.95% – 35.99%8||$2,000 - $35,000|