How Your Home Equity May Help You Escape Debt

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Key Takeaways

• Only 33% of Americans carrying debt they can’t manage felt comfortable borrowing against their home to combine higher-cost debts, according to a survey from Achieve.

• Even so, home equity lines of credit and home equity loans often carry rates far below credit card APRs, which can translate into major interest savings.

• A HELOC gives borrowers flexibility to draw funds as needed, while a home equity loan can be a better fit for a single payoff.

• If payments fall behind, the home itself can be at risk, so this approach works best with a solid repayment plan.

When you are trying to map out a path out of debt, one important resource may be hiding in plain sight: your home.

Using the equity in your home — the portion of value above what you still owe on your mortgage — can be a practical way to consolidate expensive debt and reduce the amount you pay in interest over time.

Homeowners in the U.S. are sitting on a record amount of equity, and the average mortgage holder has about $310,000, according to real estate analytics firm Cotality. At the same time, credit card balances remain costly, with the typical balance now above $6,600, according to TransUnion data.

That combination has helped revive interest in home equity products, especially home equity lines of credit, or HELOCs. Often described as second mortgages, these products let borrowers access funds up to a set credit limit and repay them under terms arranged with the lender.

Even so, surveys show that using home equity to pay off high-interest debt is not the most popular choice. In a recent Achieve and Money.com survey, fewer than a quarter of respondents said they were comfortable with the idea. The number rose to 33% among people who felt they had far more debt than they could manage, but it still trailed other consolidation options such as personal loans.

Here is a closer look at the advantages and drawbacks of using a HELOC for debt consolidation, along with how homeowners can use equity to tackle debt.

Pros and cons of using a HELOC to pay off your debts

If you have built up substantial debt, especially expensive credit card balances, a HELOC may help you secure a lower interest rate. Rates can start around 6%, which is well below the average credit card APR of more than 22%.

Because HELOCs usually do not deliver a lump sum upfront, they can also provide more flexibility than many other loans. They work as revolving lines of credit, so you can withdraw only what you need from the approved amount and control how much debt you take on. Interest is charged only on the amount you actually use.

There is also flexibility in how the money is spent, since these loans generally do not restrict the purpose of the funds. By contrast, home equity loans, which are closely related to HELOCs, are paid out as a lump sum, and interest begins accruing on the full amount right away.

Another possible advantage is that HELOC interest may be tax-deductible if the funds are used for home improvements. That does not help borrowers who only want to use the money to pay down debt, but some people draw on their line of credit more than once during the draw period, which can leave room to use it first for debt and later for a home project.

Like any financial tool, however, a HELOC has risks.

“You are borrowing against your home equity and you’re putting your house up as collateral, so in the worst case scenario, the lender essentially has a lien on your house,” says Glenn Downing, founder and principal of investment advisory firm CameronDowning. “You’re putting your family’s residence on the hook.”

If home values decline, you could also end up owing more than the property is worth.

Some lenders offer fixed-rate HELOCs, which can be attractive for debt consolidation because they create more predictable payments. In general, though, HELOCs usually have variable rates, so you may not be able to lock in a low rate and your payment can change over time. In other words, if interest rates rise, your costs can rise too.

HELOCs can also encourage borrowers to take on more debt than they need. A homeowner can often borrow up to 85% of a home’s value, minus the remaining mortgage balance. For example, if a house is worth $350,000 and the mortgage balance is $150,000, the available credit line could reach $147,500 — far more than needed to wipe out high-interest debt. Mike Miller, a financial advisor at Integra Shield Financial Group, says he always asks clients considering a HELOC why they need the extra cash.

“There may be some underlying issue there related to spending,” Miller says.

How to use a HELOC to pay off your loans

When a HELOC or home equity loan is used to consolidate debt, you are essentially borrowing from your home to pay off other, more expensive obligations such as credit cards.

At the start, the lender determines how much of your equity you can borrow against. You should also expect some upfront costs, such as application or origination fees, although some lenders may waive them or roll them into the credit line.

Once the loan is funded, you enter the borrowing period, often called the draw period, which commonly lasts five to 10 years. Depending on the terms, you may need to borrow a minimum amount at first or each time you draw from the line of credit. After receiving the money, you can begin paying off higher-cost debts.

In many cases, a HELOC is spent as needed, which makes it useful if you want the freedom to consolidate debt now and still have access to extra credit later. Miller says he sometimes recommends opening a HELOC even when a client does not plan to use the funds right away, depending on the situation.

“It’s kind of like an emergency fund,” he adds.

If you know you only want the money for a one-time credit card payoff, a home equity loan may be a better fit than a HELOC. With that option, you borrow exactly what you need to eliminate the higher-rate balance and then begin repaying the lower-rate debt right away.

Repayment terms on HELOCs vary. Some allow interest-only payments during the draw period, while others require principal and interest from the beginning. Since the goal is to make debt repayment more manageable, it is usually wise to choose a line of credit with a structured amortizing repayment plan or to pay more than the interest due so payments do not become unmanageable later.

FAQs about using home equity to pay off debt

Will using a HELOC to pay off credit cards help or hurt my credit score?

It could help, mainly because paying down credit cards lowers your credit utilization ratio. But the result depends on your overall credit profile and the scoring model used. Opening a HELOC can also cause a small short-term dip because of the hard inquiry and the new account, so do not expect an automatic increase.

What credit score and how much equity do I need for a HELOC?

Requirements vary by lender, but you will usually need a credit score of at least 620 to 680, at least 15% to 20% equity in your home, and a debt-to-income ratio below roughly 43%. Some lenders may accept DTIs as high as 50%. In general, stronger credit and more equity can improve your odds of approval and help you qualify for a better rate.

Is a cash-out refinance better than a HELOC for paying off debt?

That depends on your mortgage situation. A cash-out refinance replaces your existing mortgage with a larger one, so closing costs usually apply to the full new balance. It may make sense if you can secure a competitive mortgage rate. If your current mortgage rate is already low or you only need a smaller amount, a HELOC may be less expensive because it leaves the first mortgage in place.

What happens if I can't make my HELOC payments?

Because a HELOC is secured by your home, foreclosure is possible if you stop paying. Missed payments can also lead to fees and hurt your credit. The foreclosure process and available protections depend on the loan and state law. If you think you may miss a payment, contact your lender or servicer as soon as possible to ask about repayment or hardship options.