Should I Use a Home Equity Loan for Debt Consolidation?

High-interest debt—from credit card balances to car loan payments—can pinch your monthly finances. Consolidating your debts can help you better manage your payments, especially if you owe money to several lenders each month. If you’re a homeowner, you have a special option available to help you with debt consolidation: your home’s equity.

A home equity loan is a type of loan in which you use the equity in your home as collateral. You borrow a lump sum of money and repay it over a fixed term with a fixed interest rate.

When you use a home equity loan for debt consolidation, you’re tapping into the equity you’ve built up in your home.

Here are 2 main advantages of using a home equity loan to pay off debt:

1. Potentially lower interest rates compared with other lending solutions. Lower rates could help you reduce your monthly payment amounts and save money over time. 
2. Simplifying your finances with a single consolidated monthly payment. Combining your debts may help make it easier to stay on top of your payments. You also may have the chance to create a clear plan for becoming debt-free.

4 top reasons to consolidate debt with a home equity loan

Let’s look at how using a home equity loan for debt consolidation works, who it’s best suited for and how the process works.

1. Lower interest rates

You may often get lower interest rates with a home equity loan compared to other lending options. This is because the lender is using your home as collateral. Paying off higher interest rate debts with a lower rate equity loan could help you save more on interest.

2. Easy-to-manage payments

You could roll your existing debts into a single home equity loan. Your new consolidated payment could help you more easily manage your monthly bills. A single payment is easier to keep track of, which may also help you avoid late payments.

3. Fixed payments 

Home equity loan interest rates are usually fixed, so you won’t need to worry about the rates increasing. Combining your debts into a single loan helps you know exactly what you’ll owe each month. Then, you can build a budget that may help you get out of debt.

4. Access to more money

A conventional first mortgage may have a lower cap on how much you can borrow.  With a home equity loan, you may be able to borrow 80% or more of your home's appraised value, minus what you owe on your first mortgage.

Is consolidating debt with a home equity loan right for me?

A home equity loan may be best used for consolidating high-interest debts, such as credit card debt, personal loans and medical bills. Those types of debts often come with high interest rates.

On the other hand, smaller debts with lower interest rates could be more easily managed with debt repayment strategies such as the avalanche or snowball methods.

To be eligible for a home equity loan, you typically need to have some equity built up in your home, a solid financial history and a stable income. Your debt-to-income (DTI) ratio—which compares your monthly debt payments to your monthly gross income—should ideally be below 43%. A strong credit history and consistent record of on-time mortgage payments may also improve your chances of getting approved. 

Using a home equity loan to pay off debt is generally a smart move if:

• your finances are stable
• you have good financial habits
• you have a plan to pay down your existing debt
• you have a plan to avoid building up new debt

Taking out a loan using your home’s equity may help you tap into a substantial sum of money, but it does come with some risks. Answer these 5 questions to see if using a home equity loan to consolidate your debt might be a good option for you.

1. Do you have enough equity built up in your home? 

Lenders usually prefer a loan-to-value (LTV) ratio of around 80%. That means you need about 20% equity in your home to qualify for a home equity loan.

2. Do you have multiple high-interest debts to consolidate?

Most people have at least 1 credit card, and many people carry at least 1 auto loan as well. The average debt (excluding mortgages) in 2024 was $23,066 per person, according to Experian®.^{Footnote 1}

3. Are you disciplined with your finances?

Once you consolidate your debts into a single loan, you need to plan to make your new payments on time and in full. You’ll also need a plan to avoid adding any new debts.

4. Are you committed to paying off the consolidated debt?

Home equity loan repayment period terms can range from 5-30 years, depending on how much you’re borrowing. 

5. Do you understand the risks involved with a home equity loan?

Your home is used as collateral, so defaulting on payments could put you at risk of foreclosure. Taking on a home equity loan also increases your total mortgage debt, which could be an issue if your home’s value decreases.

How to pay off debt with a home equity loan

After you decide that a home equity loan might be a good solution for you, it’s time to get started on the path to debt consolidation and repayment. Here are 6 steps you can take to pay off debt with a home equity loan.

1. Assess your financial situation. Evaluate your debts, credit score and home equity to see if you may qualify for a loan.
2. Apply for a home equity loan. Submit your application to your chosen lender to begin the underwriting process. 
3. Pay off your existing debts. Once approved, use funds from your new loan to pay off your high-interest debts.
4. Start repaying your new loan. Begin making your new consolidated payments on your home equity loan.
5. Create a repayment plan. Add your new fixed home equity loan payments to your monthly budget.
6. Monitor your progress. Keep track of your debt repayment goals and avoid adding new debt.

More FAQs about home equity and debt consolidation

The following are some of the most common questions about using a home equity loan for debt consolidation.

Why are interest rates typically lower on a home equity loan?

Interest rates on home equity loans are generally lower than those on other types of lending solutions—like credit cards and personal loans that often are “unsecured” debt—because a home equity loan is “secured” by your home. The home equity lender has a lower risk of losing money because in the event of default, they can recover their losses by foreclosing on the home. The reduced risk to the lender leads to lower interest rates for the borrower. 

Can you use a home equity line of credit (HELOC) for debt consolidation?

Yes, you can use a home equity line of credit (HELOC) for debt consolidation. A HELOC lets you borrow against the equity in your home, which is similar to the way a home equity loan works. However, unlike a home equity loan, a HELOC works more like a credit card. It offers a revolving line of credit that you can draw from as needed. 

A HELOC can provide more flexibility, but keep in mind that it often comes with a variable interest rate. Home equity loans typically have a fixed interest rate.

What’s better for paying off debt: a home equity loan or HELOC?

Choosing between a home equity loan and a HELOC for debt consolidation depends on your situation. If you prefer a predictable repayment plan, then a home equity loan might be better. If you need ongoing access to funds and can manage variable payments, a HELOC could be more suitable.

Can you use a cash-out refinance for debt consolidation?

Yes, you can use a cash-out refinance for debt consolidation. This lets you replace your original mortgage with a new one for a higher amount than you currently owe. Then, you’ll take the difference in cash and use it to pay off high-interest debts. 

A cash-out refinance may also offer a lower interest rate compared with other types of credit. You can combine your debts into a single monthly payment, but you'll also need to consider any closing costs associated with the new mortgage and whether you may end up extending the term of your primary mortgage.

What’s better for paying off debt: a home equity loan or a cash-out refinance?

Choosing between a home equity loan and a cash-out refinance for a debt payoff depends largely on your mortgage. If you’d rather keep your existing mortgage rate and want a second loan with fixed monthly payments and a fixed interest rate, then a home equity loan might be better for you. But if you want to replace your current mortgage with a new one and use a lump sum of cash to pay off your debts, then a cash-out refinance could better meet your needs. 

How can I apply for a home equity loan for debt consolidation?

To apply for a home equity loan, look at your financial situation and make sure you have enough equity built up. Next, gather necessary loan documents like proof of income, tax returns and information about your debt. You’ll need to submit these to your lender with a home equity loan application. 

If you qualify and your application is approved, you’ll get the funds from your loan amount in a lump sum. You can use the money to pay off any high-interest debts right away. Then, you’ll make payments on your new home equity loan instead.

Considering a home equity loan for debt consolidation? We can help!

Tapping into your home’s equity could be a smart first step toward paying down debt. Navy Federal Credit Union is committed to helping you achieve your financial goals with debt management options.

If you’re considering using a home equity loan for debt consolidation, you can learn more about home equity and debt management with our MakingCents resources. Try running the numbers with our debt consolidation calculator to see how combining your debts with a home equity loan might be able to simplify your finances. 

We hope these resources help you on your way to paying down your debts and achieving financial freedom. We’re here to support you every step of the way.