No matter what your debt situation is, it is always worth considering how you can improve it. You may have a handful of loans, like auto loans or student debt, that have high interest rates. These high interest rates can add up and make it harder to pay off your debts.
Thankfully, there are several ways to lower those interest rates and consolidate your debt. If you’re a homeowner, a home equity loan or home equity line of credit (HELOC) might be a great way for you to do just that. Read on to learn more about how debt consolidation works and how you can leverage your home’s equity.
How Does Debt Consolidation Work?
Debt consolidation is when you combine multiple loans, typically with high-interest rates, into one loan with a single monthly payment. When looking for a debt consolidating loan, the goal is to find one with a lower interest rate. This reduces your potential total debt over its lifetime and enable you to pay it off more quickly.
How to Pay Off Your Debt with a Home Equity Loan
A home equity loan is a loan that is secured by your home. Your home equity is the difference between your home’s current value and the amount of your mortgage that you still need to pay off. With this type of loan, your home is used as collateral. A home equity loan can be used for several purposes, including consolidating multiple loans. Home equity loans typically have lower interest rates, which makes it easier to pay off your debt faster.
Types of Debt to Consider in a Debt Reconsolidation Loan
If you are looking to consolidate your debt with a home equity loan, there are several types of debt to consider, including:
- Loans with high interest rates: If you are paying more than 8.00% APR on any loan balances, whether a credit card or a personal loan, consider including these debts.
- Credit cards: Credit card are considered “revolving debt”, so they typically charge higher interest rates than personal loans. For credit card balances over 30% of your total limits, consider paying it off with a consolidation loan.
- Student loans: Education loans, both private and federal, have tax benefits. It’s best to contact a tax professional before paying off a student loan with a home equity loan.
Pros and Cons of Using Equity for Debt Consolidation
It’s important to weigh the pros and cons of any secured loan, especially with home equity loans. This list is a great starting point to assess whether a home equity loan for debt consolidation is right for you.
Interest rates on home equity loans and HELOCs tend to be lower than those on credit cards.
When using your house as collateral, you risk foreclosure if you can’t pay your loans.
With a home equity loan, your home serves as collateral and helps guarantee loan repayment. Because of this, they are often easier to qualify for than unsecured loans.
If the value of your house drops, you may end up owing more than the house is worth.
Consolidating your debt with a home equity loan creates one streamlined payment, so you don’t have to keep track of making payments on multiple loans and risk facing late payment penalties.
Repayment terms may stretch out your debt for ten years or longer.
The loan itself does not address problematic spending habits that may have contributed to you being in debt in the first place.
You might lose tax benefits.
We go into more detail about these pros and cons in this article.
How to Apply for a Home Equity Loan to Consolidate Debt
The process of securing a home equity loan is similar to that of applying for a mortgage. You will need to provide information on your income and employment history, and possibly even go through a home appraisal, before closing.
As you begin the process, here are some things to keep in mind.
1. Consider How Much Equity You Have in Your Home
First, you should have a good idea of how much equity you currently have in your home. How does the loan you want compare to the outstanding debt that you are hoping to consolidate? Will the existing equity that you have in your home be enough to cover the cost of revolving debts?
Home equity loans are best for those who already have significant equity in their homes. Many lenders have minimum requirement of $25,000 for a home equity loan.
2. Review Your Credit History
The credit score requirements will depend on your lender, but in general, they look for a strong credit history when they are assessing second mortgage applications. A more stable credit history will typically get you a better interest rate. If you think your score might be too low, talk to your mortgage lender. Take small, actionable steps to build your credit back over time.
3. Compare Loan Options
Compare options lenders give you for using your home’s equity before deciding which loan to pursue. Talk to a lender to gain clarity and insight into which option is best for you.
Ready to Consolidate Debt?
Having several different types of debt or loans can quickly become overwhelming, and you may lose track of all your payments, which can cause you to face late fees and a damaged credit score. Different types of loans can have different interest rates—and some can be quite high. Consolidating debt with a home equity loan isn’t right for everyone, but it might be a great tool for your financial plan.