You might consider using your home equity to repay high-interest debt.
It may be a sound strategy for you if you do the math. If you have the opportunity to use your home equity, you may be able to pay down that debt at a lower interest rate than you are currently paying.
You could be able to get out of debt faster if you have a lower interest rate. This means that more of your monthly payment goes toward principal balance payments and less towards interest. In the worst case scenario, your home could be lost if you are unable to repay the debt.
We will discuss the various ways that you can tap your home equity, as well as other options you might consider.
Is it possible to use equity from my home to repay debt?
If you meet the requirements of a lender, then yes. Your home equity may be used to finance many financial goals such as home improvements, consolidation of high-interest credit card debt, or repayment of student loans.
Like other types of financing you will have the best chance to get approved at the lowest rates if your credit is good, your income stable, and your debt-to-income ratio is low. Also, you will need to have a home equity fund that you are able to tap.
What amount of home equity do I have?
You’ll first need to assess the equity in your home. You don’t have to own a house in order to be eligible for home equity financing.
You can borrow up to 80% from your equity home. This formula will calculate how much you could borrow using home equity financing.
maximum possible financing amount = the market value of your home * 0.80 – your mortgage debt
If you have a $250,000 home and owe $200,000 in mortgage payments, home equity financing might not be available to you. However, if your mortgage balance is only $100,000, you might be eligible to borrow $100,000.
It may take a while before you are eligible for home equity financing if you have recently purchased your home or used zero-down-payment mortgages. You may not be able to pay down your mortgage in the first few years, as more of your monthly payments will go towards interest than principal.
However, if your home prices and equity are increasing rapidly, you might be eligible sooner than expected. A TransUnion report from 2022 shows that home equity has increased by 22% and 52% respectively between the first quarters 2021-2022 and five years ago.
What options do I have for using my home equity to repay debt?
You may be eligible to use three types of home equity financing to repay your debt. Each option works slightly differently and can impact how much you are able to save.
Refinance with cash-out
You can replace your existing mortgage with a cash-out refinance. You receive the extra amount as cash, which you will repay over the term of your new mortgage (often 15, or 30 years).
The amount of your home equity will determine how much cash you can borrow.
If you have the following boxes, a cash out refinance might be an option.
- A cash-out refinance loan can offer a lower interest rate than your existing mortgage or other debts.
- You would like a lump sum
- Either you won’t be extending the mortgage term very much, or you are financially capable of paying it off over longer periods. Remember that the longer the loan term, the higher the interest rate you will pay.
Home equity loan
A home equity loan is another option when mortgage rates rise. This allows you to keep a low-rate mortgage and use your home equity to repay debt.
Because you can default on your primary mortgage, a home equity loan will be considered a second mortgage. Home equity loans have terms that range from 5 to 30 years.
If:
- You are looking for a lump-sum installment loan with a fixed rate of interest
- You wish to maintain your current mortgage rate
- You have enough equity to pay your current debt . can also receive a lower interest rate than the average of all your debts
Home Equity Line of Credit (HELOC).
If you are looking to repay some existing debt and have the ability to borrow money in future, a home equity line-of credit (or HELOC) can be a great option.
HELOCs can be divided into two phases. There is a draw phase where you can borrow money and make repayments, and then there is a repayment phase when you must repay the amount you borrowed. HELOCs are often subject to variable interest rates.
If:
- You need access to a revolving line of credit
- You don’t need to change your mortgage rate.
- A variable rate mortgage is acceptable to you
Should you take equity from your house?
If you have the right circumstances, home equity can be used to help pay off your debt quicker and more efficiently. You can only find out for certain by running the numbers to see what each option might cost you.
This is how you can do it if your goal is to eliminate $20,000 of credit card debt. (Add any fees to your cost calculation.
|
Option |
Interest Rate |
Paymentoff period |
Monthly payment |
Total interest paid |
|---|---|---|---|---|
|
Credit card |
18% | 5 years | $508 | $10,472 |
| Refinance (only taking into account the amount refinanced from credit cards debt) | 7% | 30 years | $133 | $27,901 |
|
Home equity loan |
8% | 5 years | $406 | $4,332 |
| HELOC (assumes variable rate doesn’t change) | 8% | 3 years, 10 months | $506 | $3,277 |
Credit Karma’s debt repayment calculator will help you calculate your numbers.
It is important to consider how secure you feel about making the new payments. You should not use your home equity to repay debt if you feel you are at risk of defaulting or you don’t want to take that risk.
Next steps. What are my options?
If you’re looking to reduce your debt and save money, home equity financing may not be the best option. These are some other options that consolidate debt at a lower interest rate and don’t require you to use your home equity:
- Personal loans You can get an unsecured personal loan to repay your debt. These loans typically come with fixed rates and installments.
- Nonprofit credit counselling : Credit counselors can help you create a customized debt plan and provide financial advice.
- Balance transfer cards : These credit cards offer attractive introductory rates, but also come with a high balance transfer fee.
- Debt payment plan: Two popular options for creating your own debt payoff plan are the debt avalanche or the debt snowball.