Should you use your home equity to pay off high-interest debt?
Facing down high-interest debt can feel like an impossible hill to climb. If your debt feels insurmountable, you’re not alone. Overall debt in the US rose 4.4% between 2022 and 2023, according to Experian, with average credit card debt alone rising 10%. Even among seniors age 59 and older, credit card debt is up 6.4%.
If your home’s value jumped up with the recent market, you may be eyeing your newfound equity as a way out. But before you use your home as collateral for getting your debt under control, make sure you know the pros and cons of taking out a home equity loan.
What is a home equity loan?
A home equity loan — sometimes called a second mortgage — uses the equity you’ve built in your home as collateral to borrow money. That collateral unlocks access to cash at a lower interest rate than most other loans, like personal loans.
Home equity loans offer lump sum payouts at a fixed rate, so you can budget for one stable, steady monthly payment that covers both your principal and interest. Typically, home equity loans don’t have an annual fee, like some credit cards or lines of credit, and lenders tend to waive closing costs as long as you don’t pay off the loan within three years.
Does it make sense to use a home equity loan to pay down debt?
Tapping your home’s equity can help you consolidate and pay off high-interest debt at significantly lower interest than you'll pay on your separate debts, but there’s a lot at stake if you’re not able to repay what you borrow on time — including losing your home to foreclosure.
Whether it’s a good idea for you to take out a home equity loan depends on your home’s value, your credit history and your goals. Consider the following financial facts before you decide on the best path forward for paying down your debt.
Your home equity
You’ll need at least 15% to 20% equity to apply for a home equity loan. Your equity is the difference between your home’s value and the outstanding balance of your mortgage. Say your home is valued at $500,000 and you still owe $150,000 on your mortgage — in this case, you’d have $350,000 (or 70%) equity in your home.
But taking out a loan that uses up most of your equity could put you in a bad position if home values drop due to real estate trends or other reasons outside your control, leaving you owing more money than your home is worth.
Your interest rate
You don’t want to transfer your debt to a home equity loan unless you can get an interest rate that’s lower than the current rates on your credit accounts. Loan requirements vary by lender, but to get the best rates on a home equity loan, you often need good to excellent credit, low debt and at least 50% equity in your home.
A lender will also look at your mortgage payment history and your income. If you live on a fixed income — including Social Security benefits or pension withdrawals — you can qualify for a home equity loan, but the bank will consider your loan payment as part of your debt-to-income ratio, or DTI.
Your DTI compares how much debt you owe against your gross monthly income, expressed as a percentage. And if adding the home equity loan payment to your monthly obligations takes you over the lender’s required ratio, you may not qualify.
Time to pay off your debts
Terms for a home equity loan can range from 5 to 30 years — and the longer the term, the lower your monthly payments, offering a way to open up room in your budget. But if you think you can pay off your debt in under five years, a personal loan or debt consolidation loan might be a better idea.
That’s because after adding up interest and fees you might pay on a home equity loan, you could end up saving more with a five-year personal loan — even when the quoted interest rate is higher.
Yes, you could take out a home equity loan and commit to paying it off sooner. But make sure your loan doesn’t include a prepayment penalty first. Some lenders charge an “early closure” fee ranging up to 5% of your total loan amount if you pay off what you owe within the first three years.
Benefits of tapping your home equity to pay off debt
Taking out a home equity loan can free up room in your budget to pay down high-interest debts, among other benefits that include:
Lower interest rate than most credit cards to help pay off your debts faster
No annual fee, unlike many credit cards and lines of credit
Waived closing costs if you keep your loan open for at least three years
Stable monthly payments that can help simplify your budget and pay down debt
Dig deeper: 4 ways to get equity out of your home
Risks of tapping your home equity to pay off debt
However beneficial a home equity loan can be to paying off your debt, it won’t fix the underlying financial issues that got you into debt in the first place, among other potential drawbacks:
Puts your home at risk if you can’t repay what you borrow in time
Large lump-sum payout might tempt you into spending outside of your debt payoff strategy
If the value of your home drops, your loan could land you “underwater,” where the value of your home is less than the principal of your loan
Won’t fix underlying financial issues that got you into the debt
When to avoid using home equity to pay off debt
Because the risks of a home equity loan can include losing your house to foreclosure if you can’t repay your loan in full on time, it’s important to consider circumstances that may make this option one to avoid.
You have minimal equity in your home. The recent hike in home values may have boosted your equity. But if you’ve owned your home for only a few years, you may want to wait on tapping that equity, just in case the market adjusts that value down.
Your credit is poor. Credit mishaps can happen to anyone. But if yours has dropped under 670, you should work on getting your FICO score up for the best rates on a home equity loan.
Your income isn’t stable. Whether you’re a gig worker or work a job with seasonal downturns, adding an additional monthly obligation to an unstable budget may not be the answer to paying down your debt.
You may have to move before the loan is paid off. If your loan takes you to the edge of your equity, even the smallest home value drop could leave you upside down in your mortgage, which could bar you from easily selling or refinancing your home.
You’re not ready to change your financial habits. Using a home equity loan to pay down your debt can be a step toward getting your finances under control. But if you’re not ready to cut off your credit card spending, you may end up even deeper in debt down the road.
Dig deeper: Top debts to prioritize paying off before retirement
How to find a home equity loan
Not all lenders offer home equity loans, but most traditional and digital banks and credit unions do. You may even find fintechs and online lenders that specialize in home equity products.
Consider these tips to help you find the right home equity loan for your goals and budget:
Shop around lenders. Check with your bank or credit union first to see what kind of terms they offer current customers, then compare those terms with what you might get from another lender. Credit unions tend to offer lower rates and more flexible requirements than traditional banks, and often you don’t need to have your main account with one to get a home equity loan (but you do need to qualify as a member).
Review your credit report for any mistakes. You can order your own report from each of the three reporting bureaus — Equifax, Experian and TransUnion — once a year at federally authorized AnnualCreditReport.com. Review your contact information, open accounts and loans, outstanding balances, and payment information for accuracy, and report any inaccurate or incomplete information directly to the bureau.
Confirm you meet loan requirements. Lenders' standards may vary, but you’re eligible for a decent interest rate if you meet general requirements that include:
• 680 or higher credit score
• Debt-to-income (DTI) ratio of under 43%
• Proof of homeowner’s insurance
• Loan-to-value (LTV) ratio of under 85%
A FICO credit score of 720 or higher and DTI of around 35% is ideal, and combining those figures with a low LTV can get you the best available rates.
How to calculate your debt-to-income ratio
To calculate your DTI, first add up your monthly debt payments — housing expenses, credit card repayments, loan repayments and more. Then divide your total debt by your gross or pre-tax monthly income. Multiply the result by 100 to convert that number into a percentage. This figure is your DTI.
DTI ????[gross monthly income ➗total debt] ✖️100
How to calculate your loan-to-value ratio
To calculate your LTV, divide the remaining balance on your mortgage by the assessed value of your home. Multiply the result by 100 to convert that number into a percentage. This figure is your LTV.
LTV ????[mortgage balance ➗home value] ✖️100
Alternatives for paying down debt
If you’re not ready to use your home’s equity to pay off your high-interest debt, consider these top alternatives:
Balance transfer credit card. If you can qualify for a top balance transfer credit card, you just might be able to use it as an interest-free loan for up to 12 months or longer. Yet while the benefits are tempting, you must commit to paying off your balance in full within the promotional period — or risk paying hefty interest charges and fees that could negate any savings.
Personal loan. Personal loans are typically unsecured, meaning they aren’t linked to collateral like your home or car. It’s less risk for you, but more risk for the bank — which can mean higher interest rates than what you’d get with a secured home equity loan.
Debt consolidation loans. If you can get a decent interest rate, a consolidation loan can simplify your debt into one fixed monthly payment. The best rates go to those with excellent credit, and you’ll want to be wary of high origination fees and maximum terms of five to seven years — which can make for a high payment, depending on the amount of your debt.
Dig deeper: Personal loan vs. home equity loan — which is the best fit for your borrowing?
FAQs: Home equity loans, paying down debt and your budget
Learn more about the risks and rewards of tapping into your home’s equity to pay down high-interest debt.
Can I use a HELOC to pay down debt?
Yes, you can use a HELOC to pay down credit card and other debt. Home equity lines of credit are similar to a credit card, offering a revolving credit limit and variable rate. Though if you’ve found it hard to resist the temptation of your credit cards, a HELOC could put you into further debt, with your house on the line if you aren’t able to make your monthly payments on time. Learn more about how these two loans differ in our guide to comparing home equity loans and HELOCs.
Should I refinance to pay off my debt?
Refinancing your home means replacing your current mortgage with a new mortgage — which could be an option if you’re able to secure a lower interest rate than that of your current mortgage. Yet while rates are starting to come down from the year’s highs, they may not be low enough to make refinancing worth it. Refinancing also comes with all the closing costs and fees of your original loan, which you’ll want to factor into your calculations when determining next steps.
Do lenders offer autopay discounts for home equity loans?
Some lenders offer interest rate reductions of 0.25% to 0.50% if you sign up for autopay — or automatic payments from a bank account. Call the bank or credit union directly to ask about autopay or any other discounts you might be eligible for.
Is my money safe with an online-only bank or digital lender?
Yes. Digital banks and financial technology companies — or fintechs — are either FDIC-insured charter banks or partner with traditional banks to offer deposit accounts that are protected by the government for up to $250,000. The FDIC insures the safety of your money, even if the bank or fintech were to fail or go out of business. Look for terms like "member FDIC," "FDIC insured" or "NCUA insured" when comparing your options. And learn the steps to confirming your bank is insured in our guide to FDIC insurance.
Are there other strategies for paying down debt without taking out a loan?
Yes. The debt snowball and debt avalanche methods are two popular strategies that provide a simple structure to pay off what you owe across multiple credit accounts, one debt at a time. Which method is best for you ultimately depends on the type of debt you have and how you’re typically motivated to see a plan through to success. Learn more about how to incorporate these methods into your strategy with our debt snowball versus debt avalanche comparison guide.
Can I use my home equity to buy an investment property?
There are no restrictions as to how you can use the money from a home equity loan, which means you might be able to tap into your home equity to finance a rental or investment purchase. But borrowing from your home equity is risky, especially if you don't know whether an investment is a sure thing. Learn more about the risks, benefits and options in our guide to using your home equity to invest in real estate.
Sources
Study: Average U.S. Consumer Debt and Statistics, Experian. Accessed October 10, 2024.
About the writer
Heather Petty is a finance writer who specializes in consumer and business banking, personal and home lending, debt management and saving money. After falling victim to a disreputable mortgage broker when buying her first home, Heather set on a mission to help people avoid similar experiences when managing their own finances. Her expertise and analysis has been featured on MSN, Nasdaq, Credit.com and Finder, among other financial publications. When she's not breaking down the complexities of finance, she's a young adult mystery writer of an internationally acclaimed series — and counting.
Article edited by Kelly Suzan Waggoner