A New Way to Pay Off Debt: Home Equity

Juggling multiple monthly loan and credit card payments can be difficult. Even if you’re trying one of the more systematic approaches to paying off debts, you might not feel like you’re making progress or have a firm end date. Consolidating your debt into a single account can help address these issues — and more.

The benefits of debt consolidation

Debt consolidation is when you get a new loan or line of credit and use it to pay off multiple debts. The process allows you to combine several debts into a new account that has different rates and terms than your existing debts.

You might benefit from debt consolidation in several ways:

• Save money: You might be able to save money by refinancing your debt with a lower-rate loan or line of credit.
• Pay off debts faster: You could use your savings to get out of debt sooner.
• Lower your monthly payments: The monthly payment on your new account might be lower than the combined monthly payments of the debts you’re consolidating.
• Know when you’ll pay off the balance: If you consolidate debts with an installment loan, you’ll know exactly when the debt will be paid off in full.
• Spend less time managing your finances: You’ll have fewer bills to track and manage each month.

You can consolidate debt using different types of accounts, including a balance transfer credit card or an unsecured personal loan. But, if you have equity in your home, you can explore home equity loans and home equity lines of credit (HELOCs) as potential low-cost options.

Your home’s current value minus your mortgage balance is your home equity, and it can increase as you pay down your mortgage and your property’s value increases.

“Having equity in your home is a special kind of power for homeowners. It’s security,” says Chelsey Lombardi, a mortgage banker with Northwest Bank. You can use the equity to get a new loan or line of credit, which can be helpful during an emergency — or when you want to strategically pay off other debt.

Your two options: home equity loans and lines of credit

There are two common ways to borrow against your home equity without refinancing your entire mortgage:

Home equity loans

Similar to your first mortgage, home equity loans are installment loans and tend to have fixed interest rates and terms. You’ll receive the entire loan amount upfront and then pay it off with fixed monthly payments. You may be able to choose from different repayment periods when you take out the loan, which can affect your monthly payments and overall cost.

Home equity lines of credit

Similar to a credit card, a HELOC is a revolving line of credit. Your account will have a credit limit and variable interest rate, and you’ll only pay interest if and when you take a draw — or loan — from your HELOC. Often, you can take draws and make interest-only payments during an initial draw period, which might last around 10 years. Afterward, you make full principal and interest payments during a repayment period. The arrangement and variable interest rate can lead to changing monthly payments, but you may be able to lock in a rate and payment if you’d prefer.

“Home equity loans are a great option if you want a one-time, set-it-and-forget-it approach to debt consolidation,” says Lombardi. “You don’t have to monitor interest rates and your payment plan is set for a specific term.”

With a HELOC’s variable rates, you might want to monitor interest rates to see if your payment will increase or decrease. However, Lombardi says HELOCs could be better if you want to consolidate debt and have access to additional funds later without having to reapply.

“Sometimes people get both,” she adds — a loan to consolidate debt right now and a line of credit on the side for the unexpected. “The line of credit is nice because you don’t necessarily need to use it, but it’s there in the event of an emergency,” says Lombardi. 

Pros and cons of using home equity to consolidate debt

Many people use a home equity loan or HELOC to consolidate debts, but consider the pros and cons as you compare your options.

Benefits of using home equity to consolidate debt

• Large loan limits: You may be able to consolidate more debt with a home equity loan or HELOC than a personal loan or credit card. For example, with a home equity loan, you might be able to borrow up to 95% of your home’s value, minus your existing mortgage balance.
• Low interest rates: Lombardi says your credit score, available equity and loan amount can all affect your interest rates. “But typically, the home equity route is going to have a lower interest rate than unsecured debts,” she says. HELOCs may even offer a low temporary introductory rate for qualifying borrowers.
• Easier qualification: You might find it’s easier to get approved for a low-rate home equity loan or HELOC than a large personal loan or a credit card with a high credit limit.

Drawbacks of using home equity to consolidate debt

• Potential fees: There may be various fees, such as an application, origination, appraisal and early termination fee. HELOCs also have a modest maintenance fee, such as $50 a year. But lenders might let you roll some of the fees into the loan or waive certain fees.
• Using your home as collateral: Falling behind on a home equity loan or HELOC could lead to a foreclosure. Although missing unsecured loan or credit card payments can hurt your credit, result in fees and potentially lead to garnished pay, the lender or debt collector can’t take your home.
• Minimum loan requirements: There might be a minimum required loan amount that’s more than you need to consolidate debt. A balance transfer credit card with a 0% intro offer might be a better option if you don’t have a lot of debt to consolidate.

Get prepared to consolidate your debts

You’ll want to check a few numbers to set yourself up for success:

• Calculate your home equity using your mortgage balance and estimated market value.
• Figure out the combined balance of the debts you want to pay off.
• Review your credit scores to see if you’ll meet lenders’ minimum score requirements.
• Compare rates for home equity loans and lines of credit.

If you have enough equity and will likely benefit from consolidating, you could start comparing offers from different lenders.

Northwest Bank has a quick application process with minimal closing costs and competitive rates, and you can apply online or in person at a local office. Get started now, or contact a mortgage professional to learn more.