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Smart ways to consolidate debt with a home equity loan

Consolidating debt using your home's equity could be a smart plan to manage high-interest credit card debt, student loans, medical bills and other personal loans.

Marco Pedri
September 12, 2022
Blog overview

What is debt consolidation?

Pros and cons of consolidating debt with home equity

The best home equity loans for debt consolidation

How to apply for a home equity loan

Which home equity loan has the lowest monthly payments?

Which home equity loan gets you money the fastest?

Which home equity loan has the lowest rates?

Consolidating debt using your home's equity is a smart debt management plan as it 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. 

What is debt consolidation?

Debt consolidation is the process of taking out one loan to pay off multiple forms of debt elsewhere. If you decide to take out a home equity loan to do so, you would be leveraging 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. Having multiple outstanding debts with different interest rates is not only difficult and time-consuming to manage, but 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 the equity of your home at a single interest rate and pay off your multiple forms of existing debt in a single payment. This will allow you to manage your debts easier, increase your repayment period and secure a lower interest rate for the total debt amount.

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 truly understand whether a home equity loan for debt consolidation is right for you.

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 own financial situation, you may want to consider this option.

Lower interest rate: If you’re a homeowner with good credit, home equity loan or home equity line of credit (HELOC) lenders may award you with 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. This is not always the case though. Be sure to consult the expert opinion of a financial advisor.

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 considered unsecured loans 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 you miss a monthly payment. This means, if you fall behind on payments, it could result in mortgage default and foreclosure.

Your home's value could change: If you borrow against the equity of your home 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 your home is fully paid off and you decide to get an equity loan for debt consolidation, you can raise the timeline back up to 30 years again until the home is paid off.

Fees: There are certain 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 counselling.

Losing your home or paying more than you need to is the last thing we want to see happen to you. It is best to avoid navigating tough conversations with loved ones about money. This is why you should seriously consider if obtaining a home equity loan and using your home as collateral is the right decision for you.

What home equity loans are best for debt consolidation?

Using home equity to consolidate debt is a great option for those looking to access funds. Luckily, there are multiple options for debt consolidation loans that use home equity that you can choose from.

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

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 easiest and most streamlined application processes for a home equity line of credit (with no required monthly payments*, might we add), we will go over the typical application process most lenders will follow for home equity loans.

Step 1: First, you need to figure out your home equity loan eligibility. Arriving at your home equity loan eligibility depends on a few major 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 tap into. You may be offered a HELOC of anywhere up to $400,000 depending on the lender's criteria. Depending on your location and the lender, you may be offered only 80% of the home's total value. This would limit 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. If you have a higher credit score, you will likely be offered a lower interest rate. 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 agreeing to.

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.

Which home equity loan has the lowest monthly payments?

There is nothing lower than $0 a month, which is what 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 5 year term. At that time, you can choose to refinance for another 5 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*, no hidden fees, and removed all the confusing financial jargon to help you find the right financial solution to meet your needs. It’s the type of loan many homeowners have been waiting for.

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 in that 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. This means 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 tap into. You may be offered a HELOC of $100,000 which is 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 as well as payments and interest to the $50,000 portion you have taken out from your HELOC.

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 larger amount than your current, existing mortgage balance and 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 your home needs to be valued at a higher amount than what your existing loan is. Keep in mind that depending on a couple of factors such as your region, location, and the lender you choose, you may not be able to refinance the full 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 amount of the loan 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 compared to the interest rate you would receive on a home equity loan or line of credit.

Keep in mind, 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.

Consolidate debt with Fraction

Looking for a flexible way to consolidate debt? With no required monthly payments*, no age restrictions, and no exit penalties, the Fraction Mortgage may be the right solution for you.‍

Get your free estimate today

Disclaimer: Information in this article is general in nature and not meant to be taken as financial advice, legal advice or any other sort of professional guidance. While information in this article is intended to be accurate at the time of publishing, the complexity and evolving nature of these subjects can mean that information is incorrect or out of date, or it may not apply to your jurisdiction. Please consult with a qualified professional to discuss your specific situation and confirm any information.