How to Leverage Your Home Equity to Consolidate High-Interest Debt 

1.26.2023 | Category: Article

High-interest debt can be one of the most challenging factors getting in the way of you achieving your financial goals. From high-interest credit card debt to high-balance loans like medical bill and student loans, these monthly payments can put a real pinch on your budget. 

But if you own your own home, you may be eligible to tap your home equity to help you pay down your debts faster and reach your financial goals. 

What's a Home Equity Loan

A home equity loan is a type of loan that allows you to borrow money using the equity in your home as collateral. Home equity is the difference between the value of your home and the amount you still owe on your mortgage. You can use this equity to borrow money through a home equity loan or a home equity line of credit (HELOC).

There are two types of home equity loans that borrowers typically use:

• Home equity loan: A home equity loan is a lump sum loan that is secured by your home. You can use the loan to pay off high-interest debt, such as credit card balances or personal loans. Once you've taken out the loan, you'll make fixed monthly payments to pay it back.
• Home equity line of credit (HELOC): A HELOC is a revolving line of credit that is secured by your home. You can borrow against the line of credit as needed, and the interest rate will typically be variable. You can use the funds from a HELOC to pay off high-interest debt and then make payments on the HELOC as you use the credit.

What Kind of Debts Can I Pay Off Using a Home Equity Loan?

According to Money Crashers, the average credit card holder has more than $6,000 in credit card debt, closing in on 2019’s all-time high. With interest rates that range between an average of 16% - 25%, credit card balances can be one of the most difficult types of debt to pay off. Other types of debt, including medical debt and student loans, utility bills and auto loans, can all typically carry higher interest loans than home equity loans. 

Consolidating your debt with a home equity loan or HELOC can have some advantages over other types of debt consolidation. The interest rates on home equity loans and HELOCs are typically lower than the interest rates on credit cards, so you may be able to save money on interest over time. Additionally, the interest paid on a home equity loan or HELOC may be tax-deductible, which can further reduce the cost of borrowing.

However, it's important to note that using your home equity to consolidate debt can also be risky. A home equity loan is secured by your home, just like any other mortgage loan.

Is a Home Equity Loan the Best Option for Consolidating debt?

A home equity isn’t the only option for consolidating debt. In fact, there are several options for consolidating debt including balance transfers, personal loans, or debt settlements. 

Balance transfers typically involve transferring the balances of multiple credit cards to a single credit card with a lower interest rate for a temporary period. For example, some credit cards pay offer a 0% introductory rate on balance transfers for the first six billing cycles. Be cautious and read the fine print, however, because these promotional offers are often only valid for a limited time and the interest rate can jump up to a much higher interest rate one the defined time period is over. 

Personal loans are another option for paying off multiple debts. The interest rate on a personal loan may be lower than the interest rates on your existing debts, which can help you save money over time. However, they can be a little tougher to qualify for, especially if your existing debt is making a negative impact on your credit score. 

Debt settlements are one fo the riskiest options for paying off high-interest debt: This is a process in which a company negotiate with your creditors to reduce the amount of debt you owe. This may help you get out of debt faster but it can have a negative impact on your credit score and it may result in legal actions from the creditor.

How Do I Know if a Home Equity Loan is the Best Option for Me?

Home equity loans or home equity lines of credit (HELOC) are a great option if you have high-interest debt that you’re looking to pay down and enough equity to cover the loan balance. To qualify for a home equity loan, you generally need to meet the following criteria:

Homeownership: You must own a home and have a certain amount of equity in it. The amount of equity you need will depend on the lender, but most require at least 20% equity in the home.

Credit Score: Lenders typically require a minimum credit score to qualify for a home equity loan. The minimum score can vary, but most lenders look for a score of 620 or higher.

Income: Lenders will want to see that you have a steady income and are able to make the payments on the home equity loan. You may need to provide proof of income, such as pay stubs or tax returns.

Debt-to-income Ratio: Lenders will also look at your debt-to-income ratio to determine if you can afford the home equity loan payments. Your debt-to-income ratio should be less than 43% to qualify for a home equity loan.

Loan-to-value Ratio: Lenders also have a limit on the loan-to-value ratio, which is the amount of the loan compared to the value of the property. Most lenders allow a maximum loan-to-value ratio of 80-85%.

Property Condition: Lenders will also check the condition of the property, to make sure that the home is in good condition and the repairs are done if needed.

It's important to note that these are general guidelines, and lenders may have different requirements. Additionally, you should consider your own financial situation, the pros and cons of a home equity loan, and the risks involved before applying. 

If you’re ready to explore your options with a reputable lender, contact Mutual of Omaha Mortgage to learn how using your home equity can help to consolidate your debt and reach your financial goals.