Smart ways to consolidate debt with a home equity loan

Consolidating debt using your home's equity allows you to pay off your high-interest credit card debt, student loans, medical bills, and other personal loans in the form of one lump sum debt. 

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What is debt consolidation?

Debt consolidation is when you use one loan to pay off multiple forms of debt elsewhere. If you decide to take out a home equity loan, you will leverage your home's equity for debt consolidation.

For example, let's create a list of possible debts with the outstanding balance for each one and the interest rate.

• Home improvement loan = $6,500 at 8.49% interest.
• Credit cards = $2,300 at 21.99% interest.
• Student loans = $8,200 at 7.54% interest.

In this example, the total outstanding debt you owe equals $17,000 with various interest rates. Managing multiple outstanding debts with different interest rates is challenging and time-consuming, and it can also make it difficult to prioritize which loans to pay off first.

By using a home equity loan for debt consolidation, you can borrow the $17,000 against your home's equity at a single interest rate and pay off your multiple forms of existing debt in a single payment. Consolidating debt with home equity can allow you to manage your debts easier, increase your repayment period and secure a lower interest rate for the total debt amount.

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What are the pros and cons of consolidating debt with home equity?

As great as it sounds to consolidate debt by getting a home equity loan, there are pros and cons you should consider before making this decision. It is important to weigh both sides to understand whether a home equity loan for debt consolidation is right for you.

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Pros of consolidating debt with home equity

There are advantages to using a home equity loan for debt consolidation, which is why, depending on your financial situation, you may consider this option.

Lower interest rate: If you're a homeowner with good credit, home equity loan or line of credit (HELOC) lenders may award you a low-interest rate.

Consolidate multiple debt obligations into one payment: Similar to a balance transfer, a benefit of using a home equity loan for debt consolidation is combining different types of debt into one predictable payment.

Possibility of a tax deduction: Depending on your situation, the interest you pay on a home equity loan may be tax deductible. It is only sometimes the case, though. Be sure to consult the expert opinion of a financial advisor.

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Cons of consolidating debt with home equity

The cons of consolidating debt with home equity come to the forefront when you understand what a home equity loan is — a secured loan.

Risk of losing your home: Essentially, by using the equity in your home, your home is used as collateral for the debt. Balance transfer credit cards and personal loans are unsecured, meaning if you do not pay, there is no tangible asset for the borrower to go after.

On the other hand, a home equity loan or HELOC is a secured loan meaning the borrower has a tangible asset they can go after should they miss a monthly payment. If you fall behind on payments, it could result in mortgage default and foreclosure.

Your home's value could change: If you borrow against your home's equity and your home's value decreases, you may end up owing more than what your home is worth.

Longer timeline: In the example of a cash-out refinance or a second mortgage, you may be extending the amortization period of your loan. For example, if you have five years remaining on your existing mortgage until you pay off your home and decide to get an equity loan for debt consolidation, you can raise the timeline back up to 30 years.

Fees: There are specific fees and closing costs associated with getting a home equity loan, including origination fees, legal fees, repayment fees, and, if you decide to engage a professional, credit counseling.

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What home equity loans are best for debt consolidation?

Using home equity to consolidate debt is an excellent option for those seeking funds. Luckily, there are multiple options for debt consolidation loans that use home equity:

• Fraction Mortgage
• Home equity line of credit (HELOC)
• Home equity loan or second mortgage
• Cash-out refinance
• Reverse mortgage

You can click on each option to learn more about each equity loan for debt consolidation and pick one that is right for you.

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How do I apply for a home equity loan?

Borrowing from your home equity is easier than you think with the help of Fraction.

Although Fraction offers one of the most accessible application processes for a home equity line of credit (with no required monthly payments*, might we add), we will review the typical application process most lenders follow for home equity loans.

Step 1: First, determine your home equity loan eligibility. Arriving at your home equity loan eligibility depends on a few significant factors.

• Your existing mortgage(s)
• Your home's value
• Lender criteria

For example, if you have an existing mortgage of $350,000 and your home is valued at $750,000, you have $400,000 of built equity you could access. Depending on the lender's criteria, you may receive a HELOC of up to $400,000. Depending on your location and the lender, you may receive only 80% of the home's total value. This limit would restrict your HELOC to $250,000 (80% of 750,000 = $600,000 minus the existing mortgage of $350,000).

Step 2: Once you have determined your HELOC eligibility, the interest rate is determined based on your credit score and credit health. You will likely receive a lower interest rate if you have a higher credit score. If you have a lower credit score, you might still be eligible for home equity loans, but you may pay a higher interest rate. It is up to you to determine what interest rate you are comfortable accepting.

Step 3: The final step is to accept the offer you were given by the lender or decline and continue searching.

If you accept the offer, you will now have access to pull funds from the equity to consolidate debt.

If you decline, you can either continue searching and start again at step 1 with a different lender or pause your search to reassess your needs.

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Which home equity loan has the lowest monthly payments?

There is nothing lower than $0 a month, which you get with a Fraction Mortgage.

Rather than paying a monthly minimum payment as you would with other debt consolidation options, the Fraction Mortgage allows you to defer payments until the end of a five-year term. At that time, you might choose to refinance for another five years, or you can pay off the loan amount.

Homeowners who have worked with Fraction have lowered their debt-to-income ratio by as much as 50%.

We've built the Fraction Mortgage with no required monthly payments*and no hidden fees, and removed all the confusing financial jargon to help you find the right financial solution to meet your needs.

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Which home equity loan gets you money the fastest?

A home equity line of credit or a HELOC is the fastest home equity loan to access money.

It is similar to a second mortgage or home equity loan but differs because you only draw a portion of the available funds as you need them. Unlike a cash-out refinance, where you refinance your home for a larger loan and the difference in the previous loan vs. the new one is what you pocket, a HELOC is a line of credit you can tap into as needed. You only pay interest on the amount you pull out and use. 

For example, if you have an existing mortgage of $450,000 and your home is valued at $750,000, you have $300,000 of built equity you could access. You may receive a HELOC of $100,000, a separate loan from your original mortgage that you can tap into as you need.

If you take out $50,000, you will still have your original $450,000 mortgage to cover and payments and interest to the $50,000 portion you have taken from your HELOC.

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Which home equity loan has the lowest rates?

If you are looking for an alternative option with the lowest rates, your best option is a cash-out refinance or "cash-out refi" loan.

A cash-out refinance loan is when you refinance your home for a more significant amount than your current, existing mortgage balance. The difference between your existing loan vs. the new loan is what you can pocket to pay off high-interest debt like personal loans and credit cards.

The one caveat to this method is that your home needs to be worth a higher amount than your existing loan. Keep in mind that depending on a couple of factors, such as your region, location, and the lender you choose, you may need help to refinance the total 100% value of your home. Instead, you may be limited to only 80% of the property's current value. We will break this down in the example below.

For example, if you have an existing mortgage of $450,000 and your home is valued at $750,000, if a lender will only allow you to refinance 80% of the property's value, then you would be able to do a cash-out refinance of $600,000 leaving you with $150,000 in your pocket.

$750,000 (current value) x .8 (80% of the home's total value) = $600,000.

$600,000 (total allowable refinance of 80%) - $450,000 (existing mortgage) = $150,000

In this scenario, the interest you pay is on the total loan amount, which is $600,000, not just the portion you use to pay off debt. Although refinancing might seem daunting or not the best option, you still may receive a better interest rate on a new mortgage than on a home equity loan or line of credit.

Refinancing your mortgage may result in a longer loan term, and you may need to take on a higher mortgage rate.

If you are worried about rising interest rates impacting your mortgage payments, you can extend the amortization period of the new mortgage to 30 years, which will keep monthly payments low.