- Homeowners may be able to borrow against the value of their homes to consolidate multiple debts into a single loan with a lower interest rate.
- Home equity loans and home equity lines of credit (HELOCs) are the most common tools for using equity to consolidate debt.
- The benefits of debt consolidation via home equity can include simplified payments, lower interest rates, and lower monthly payments.
Home Equity for Debt Consolidation: An Overview
Feeling overwhelmed by debt? You're not alone — the average American consumer owes $104,215 in debt.[1] Between credit cards, student loans, medical debt, auto loans, and mortgages, many are looking for ways to better manage debt.
Homeowners have access to unique financial tools that may be able to alleviate some of the burden of debt: home equity loans and home equity lines of credit for debt consolidation.
In this article, we will explore these potential solutions, explain the potential pros and cons of using home equity to consolidate debt, and discuss situations in which this debt management strategy makes sense.
What Is Debt Consolidation?
Debt consolidation is the process of rolling multiple debts into a single loan or credit line. For example, if you have balances on five credit cards and take out a single loan to pay off those balances, the debts have been consolidated. Where there were five monthly credit card payments to manage, there is now only one.
What Is Home Equity and How Is It Used To Consolidate Debt?
Home equity is the value of your home minus any amount owed on the home. Homeowners can borrow against this value to get cash, which can be used for a number of purposes, including debt consolidation. By converting some of your home equity to cash and using that cash to pay off multiple debt balances, you replace the multiple monthly debt payments with a single monthly payment on the new equity-based loan or credit line.
However, it is important to understand that borrowing against your home equity secures the loan with the property. This means that the home serves as collateral for the loan. Failure to repay the loan could result in a foreclosure on your home.[2] This consideration should be balanced against the benefit of lower interest rates. This use of collateral allows lenders to offer lower interest rates on debts than to those borrowers without.[3]
You can quickly calculate home equity by subtracting the property’s current mortgage balance from its current value. However, lenders generally will not allow homeowners to borrow against the full value of their equity. Lenders typically expect homeowners to retain at least 20% equity in the property.[2]
There are two common methods of accessing cash from home equity: home equity loans and HELOCs.
How To Use a Home Equity Loan for Debt Consolidation
A home equity loan allows homeowners to borrow against their equity in a single lump sum, repaid in monthly installments that begin immediately once the loan is issued. Home equity loans typically come with a fixed interest rate, which means that the interest rate will not change over the life of the loan.[4]
You could potentially use a home equity loan to secure enough cash to cover existing debt balances. Once the existing debts are paid off with the funds from the new home equity loan, you no longer need to worry about making multiple payments on those debts. Instead, you make one payment on the new home equity loan.
How To Use a HELOC for Debt Consolidation
HELOCs are similar to home equity loans. However, instead of offering a lump sum, HELOCs offer revolving lines of credit. This means HELOCs function similarly to credit cards. Homeowners can charge expenses to the HELOC as needed during the draw period. Then repay the loan during the repayment period.
HELOCs often come with a variable interest rate, which means that the interest rate changes with fluctuating market rates. However, fixed-rate HELOCs are also available for those who prefer the predictability of having a rate “locked in.”
You could potentially open a HELOC and borrow enough against that credit line to pay off your other debts. Then, you would make a single HELOC payment each month rather than paying multiple debts each month.
Potential Advantages of Using Home Equity for Debt Consolidation
Consolidating debt with a home equity loan or HELOC can offer several financial benefits.
Simplified Payments
All debt consolidation plans benefit from simplified payments. As discussed, when a new loan is used to repay multiple debts, the borrower can focus on repaying that single loan. This is more manageable than continuing to make multiple payments to multiple creditors each month, often with different due dates.
Lower Interest Rates
Because home equity loans and HELOCs are secured by real estate, they represent less risk for lenders than unsecured debt. This allows lenders to offer lower interest rates on home equity loans and lines of credit than on other consumer loans.[3] A lower interest rate saves you money over the term of the loan by reducing overall interest expense. Enter your debts into a debt consolidation calculator to see how much you could potentially save by consolidating with a home equity loan or HELOC.
Lower Monthly Payments
A lower interest rate can mean lower monthly payments due to less of each payment being allocated to interest. Debt consolidation could also reduce monthly payments further by extending the repayment period. For example, if you replace multiple debts with payoff timeframes of three to five years with a 15-year home equity loan, your balance is divided over many more payments. This brings the monthly payment down. Just be aware that longer repayment periods can potentially cost more in total interest expense over the life of the loan.
Opportunity for Long-Term Credit Score Increases
Since credit scores are affected by payment history, on-time payments can improve your credit score over time. Consolidating debt makes it easier to manage payments, helping you make payments on time and avoid credit score penalties for late payments.
Possible Drawbacks of Using Home Equity for Debt Consolidation
In addition to the benefits of using home equity for debt consolidation, there are also a few downsides to know.
A Default Can Result in Foreclosure
When a home is used as collateral, the borrower risks losing the home if the loan is not repaid.
Potential Fees
There may be costs associated with applying for and opening a home equity loan or HELOC.[5] Ask your lender about applicable rates and fees.
Short-Term Negative Impact on Credit Score
Opening any new loan or line of credit can temporarily lower your credit score by decreasing the average length of open credit lines.[6] The impact may be minor but is worth noting.
How To Decide if Home Equity Debt Consolidation Is Right for You
Home equity debt consolidation may work for those who:
- Have substantial equity in their homes
- Can qualify for a HELOC or home equity loan
- Are confident the home equity loan or HELOC can be repaid
- Can get a much lower interest rate on the home equity loan or HELOC than the rates on their current debts
Debt consolidation often works well with:
- High-interest credit card debt. There is a lot of room to bring these interest rates down and save money with consolidation.
- Personal loans. Personal loans are typically unsecured, so they usually have higher interest rates than home equity loans and HELOCs.
You should exercise extra caution when consolidating the following:
- Student loans. Student loans may come with special features, like forgiveness plans, compensation-based repayment plans, and low interest rates. Using a HELOC or equity loan to pay off this type of debt early could cause you to lose these advantages.
- Auto loans. Auto loans are often secured by the automobile. This means failure to repay the loan could result in repossession of the vehicle. For many borrowers, this is preferred over risking foreclosure on their home for failure to repay the loan.
- Medical debt. Borrowers might be able to negotiate the terms of repaying medical debt directly with their healthcare providers or creditors. This could result in a lower interest rate and/or lower payment without using your home as collateral or paying fees associated with a consolidation loan.
- 0% interest credit card debt. Replacing a no-interest debt with a low-interest loan would likely cost more money rather than improve your finances.
The Bottom Line
Using home equity to consolidate debt can help borrowers simplify finances and reduce interest expenses. However, some borrowers may not be comfortable using their home as collateral for a consolidation loan. If you would prefer to consolidate debt without using home equity, consider consolidating debt with a personal loan instead.
The property securing the CHELOC must be located in a state where PNC offers home equity products. PNC does not offer the CHELOC product in Alaska, Hawaii, Louisiana, Mississippi, Nevada and South Dakota.
