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Should You Use a Home Equity Loan to Consolidate Your Debt?

Home equity loans can be a convenient option if you need to to borrow large sums of money at a lower interest rate. But first you need to consider the pros and cons.

A blue craftsman style home with white trim.
hikesterson/Getty Images

A convenient way to unlock the value of your home and access cash at a low interest rate is through a home equity loan. When you take out a home equity loan, it means you're borrowing against the equity you've built up in your home (after all, the more mortgage payments you make, the more equity you have). Your home's value secures the loan, so a bank or lender feels comfortable extending you a high line of credit. 

Lenders typically want to see that you have at least 15% to 20% equity accrued in your home before approving you for a home equity loan. Once approved, you can either receive the money as a lump sum that you pay back with consistent payments a fixed-interest rate, or if you use a home equity line of credit, or HELOC, you can keep a revolving line of credit open for years and withdraw from it as you see fit, but your interest rate will rise and fall over time. 

Right now home equity rates are hovering just under 7%, which means they are a lower-rate option than other types of financing such as credit cards or personal loans (which are currently averaging 10.7% according to Bankrate, CNET's sister site). 

Read on to learn about the benefits and drawbacks of using a home equity loan (commonly referred to as a second mortgage) to consolidate debt, as well as alternative options for reducing debt and getting your finances back on track.

Should you use home equity to consolidate debt?

Some of the reasons to borrow against your home equity to consolidate debt include paying off higher-interest consumer debt such as credit cards or student loans. Essentially, you can use the funds for whatever you want – which is why it's critical to make sure you can manage your money responsibly, such a high line of credit over an extended period of time. If you'll be tempted to use your home equity loan for expenses, such as for vacations or non-essential life events instead of paying down -- and keeping down -- your debt, it may not be the right solution for you. 

Pros of using home equity to consolidate debt

Home equity loans and HELOCs allow you to take advantage of homeownership by unlocking your property's equity as cash. They can also give you access to the money quickly, within as little as one to two months.

Lower interest rate

Home equity loans tend to have low interest rates which saves you money over the course of your loan term. For example, if you have a 21% credit card APR, you can pay it off with a 7% HELOC, saving your thousands of dollars in interest over the lifetime of your loan.

One lower monthly payment

Combining all of your debts into one monthly payment makes paying off your debt a more manageable and streamlined process and should lessen the amount you pay every month.

Tax deduction for home renovations

If you use your home equity loan for home renovations or repairs, you can deduct it from your taxes.

Cons of using home equity to consolidate debt

Make sure you are ready for the responsibility of managing a large sum of cash over a period of years. If you use your equity loan or HELOC to pay off credit card debt, but don't change your behavior and financial habits, you'll end up right back in debt again and your house will be on the line -- not just your credit score. That's why it's important to be thoughtful and judicious about when and why you borrow against your home's value.

You can lose your home

The most obvious downside to a home equity loan is that your bank or lender can repossess your property if you fail to make payments or default on your loan for any reason.

A home equity loan can increase your debt

If you don't properly manage your loan and other debts moving forward, you can also end up in more debt. As in, if you pay off credit card debt but don't change your spending habits, you'll end up on the hook for credit card payments in addition to your home equity loan payments, which cancels out the reason you took out the loan in the first place.

Loan limits

If you have a low or less-than-stellar credit score, or you're already carrying a lot of debt, you may not have access to a very high loan amount, and the interest rate a lender will charge you will likely be higher, too.

Alternative ways to consolidate debt

Before you commit to a home equity loan or HELOC and put your house on the line, consider the other types of financing available to you. Rather than taking out a second mortgage, you can consider options such as a 0% interest credit card or a personal loan, which doesn't come with the risk of losing your home -- though they may come with higher interest rates since they are unsecured loans. 

Balance transfer credit cards

Such balance transfer credit cards typically offer a 0% interest rate for an introductory period, which can range anywhere from six to 21 months. After that, your interest rate will rise and you'll be paying a higher APR. 

Personal loans

You can apply for a personal loan from a bank or other financial institution. You may pay a higher interest rate, but you won't have to put your home up as collateral to secure the loan.

Overall debt management

Another option is to enter into credit counseling. You can work with a non-profit agency that charges little to no fees, and your credit score won't be negatively affected. Counseling services can negotiate lower balances and interest rates with your creditors on your behalf, as well as create a plan for you to stay out of debt. Beware of debt consolidation scams and make sure you work with a reputable organization if you go this route.

How to apply for a home equity loan to consolidate debt

To qualify for a home equity loan you need to be approved by a bank or lender. Lenders typically want to see that you have at least 15% to 20% built up in your home. If you have enough equity, lenders then want proof that you are creditworthy and capable of paying back the loan. Usually, lenders require a minimum credit score of 620 (the higher your score, the better your chances are for loan approval, and at a lower interest rate), a debt-to-income ratio of 43% or lower, and proof of your income, among other types of financial documentation. You may also need to pay for a new home appraisal for an accurate and up-to-date assessment of your home's current market value

The bottom line

A home equity loan can help you consolidate and pay off debt at a lower interest rate, but you have to weigh the pros and cons of using your home as collateral to secure a loan. As long as you make on-time payments and continue to pay down your debt, home equity loans can be cost-effective ways to unlock your home's value.