Home equity loans for debt consolidation

If you’re struggling to pay off credit cards or other high-interest debt, you aren’t alone. In the final months of 2024, consumer credit card debt hit a record high of $1.21 trillion. Credit cards come with high borrowing costs, and compounding interest makes them difficult for many people to pay down. If you have equity in your home, you can save money by consolidating high-interest debt with a lower-cost home equity loan. Understanding how a home equity loan works will help you decide if it’s the right option for you.

Using a home equity loan to pay off debt

A home equity loan is a second mortgage with a fixed interest rate that allows you to borrow a lump sum you can use any way you like. Home equity loan interest rates generally are lower than rates on credit cards or personal loans, so using one to pay off those debts can save you money. Your lender won’t let you borrow all your equity – you’ll need to keep some in your home. The repayment period on a home equity loan usually is shorter than it is for a mortgage.

How does debt consolidation work with a home equity loan?

Once your lender approves your home equity loan, they’ll send you a lump-sum payment that you use to pay off your high-interest debts. You’ll then make monthly payments on your home equity loan, which you pay in addition to your primary mortgage.

For example, you can take out a home equity loan to tackle credit card debt. Many credit cards have interest rates in the double digits, making them difficult to pay off in a timely fashion. Using the money you borrow with a home equity loan to pay off your debts and consolidate them into a single loan payment can allow you to pay it off faster, pay less interest, and reduce your debt-to-income ratio.

Rocket Mortgage^® offers home equity loans for primary and secondary homes.*

Pros and cons of using home equity to consolidate debt

Tapping into your home equity to consolidate debt has pros and cons.

Pros

Advantages of using a home equity loan for debt consolidation include:

• A relatively low interest rate. Because your home is collateral for a home equity loan, you’ll pay a lower interest rate than an unsecured loan.
• Flexible credit score requirements. Since you borrow your equity, you don’t need a sky-high credit score to get a home equity loan. Check with your lender, as the minimum required credit score will vary depending on the loan and lender.
• Possible tax breaks. The interest you pay on a home equity loan may be tax-deductible.

Cons

Here are some disadvantages to using a home equity loan for debt consolidation:

• You risk losing your home if you default. You’re using your home as collateral, so your lender could foreclose on your home if you don’t repay your loan as scheduled.
• You stretch your timeline. By adding a second mortgage, you take on more overall debt and may extend the amount of time it takes to pay off your original mortgage.

Who’s eligible for a home equity debt consolidation loan?

Before approving a home equity loan, your lender will calculate your equity and review your credit score and DTI ratio. Requirements vary but expect to need at least 15% – 20% equity in your home, a credit score of at least 620, and a DTI ratio of less than 50%. How much you can borrow with a home equity loan depends on the lender and the amount you have in equity.

Should you use a home equity loan to consolidate debt?

For most people, their home is their most valuable possession. You may work 15 – 30 years to pay it off, so be careful when deciding if a home equity loan is a good idea. Some financial experts recommend using your home’s equity only for emergencies, such as unexpected medical bills.

Think carefully about the ultimate purpose a home equity loan for debt consolidation would serve. Consider your future goals, other financial aspirations, and whether you plan to own your home long-term.

How to apply for a home equity loan to consolidate debt

Once you’ve decided to take equity out of your home, follow these steps:

1. Determine how much equity you have

Before you apply for a second mortgage, it’s important to calculate your home equity. Do this by subtracting the amount you still owe on your mortgage from the current value of your home. Most lenders only allow you to borrow 80% to 85% of your home’s value minus how much you owe on your primary mortgage.

2. Check your credit

A high credit score can help borrowers get a second mortgage with more favorable terms. If you don’t meet the minimum credit score for a home equity loan, talk with your mortgage lender or take steps to raise your score.

3. Compare loan options

Compare home equity loan offers from different lenders and choose the one with the best terms, such as interest rate, monthly payment, and length of repayment. Consider working with a financial advisor to choose the best path for you.

Alternatives to using a home equity loan as a debt consolidation loan

Some alternatives to a home equity loan may be a better option for debt consolidation.

Home equity line of credit

A home equity line of credit is like a home equity loan, but you receive a line of credit instead of a lump sum. With a HELOC, you can borrow up to 85% of your home’s value minus the amount you owe on your primary mortgage. A HELOC is like a credit card in that you can carry a balance from month to month. Unlike a credit card, you can make interest-only payments during the initial draw period.

Most HELOCs have a variable interest rate and may be preferable to a home equity loan because you don’t have to use the entire amount. You pay interest only on the amount you borrow, not the total line of credit. Consider all the pros and cons of HELOCs before applying.

Rocket Mortgage^® doesn’t currently offer HELOCs.

Cash-out refinance

A cash-out refinance offers some of the same benefits as a home equity loan. You’ll take out a new primary mortgage based on the current value of your home, use the proceeds to pay off your current mortgage, and keep the difference. You repay what you’ve borrowed with your new mortgage payment.

A cash-out refinance can be a wise debt consolidation strategy because it’s based on your primary mortgage and poses less risk to your lender. As a result, you’ll get a low mortgage rate relative to most other options. On the downside, you’ll have to pay closing costs for a cash-out refinance.

Personal loan

The interest rate on personal loans is lower than on credit cards but higher than a primary mortgage. If your personal loan is unsecured, the rate you get will depend on your credit profile and financial history.

Look for a personal loan without a prepayment penalty. Also, if you extend personal loan payments past your designated repayment period, you’ll pay additional interest.

No-interest balance-transfer card

A zero-percent interest balance-transfer card allows you to move your existing credit card debts to a new card that charges no interest for a specific period. This period usually lasts 12 – 18 months, so make sure you can pay off your debts before this period ends. You may be required to pay a transfer fee on some cards, so double-check the loan conditions.

401(k) loan

A 401(k) loan allows you to borrow from your retirement savings. A 401(k) is an employer-sponsored savings plan that sets aside pre-tax dollars from your paycheck for retirement. A 401(k) loan is still a loan – you’ll have to repay what you borrow, plus interest, no more than 5 years after taking out the loan.

A 401(k) loan doesn’t affect your credit score, but failing to repay it could leave you in more debt than when you started. You could risk your retirement savings and be subject to tax penalties if you can’t repay what you borrow.

The bottom line: Debt consolidation with a home equity loan can be a good option

It’s possible to consolidate debt in several ways. Compare your financial situation to the criteria previously discussed to decide whether it makes sense for you to take out a home equity loan. If not, another method of debt consolidation – such as a cash-out refinance, personal loan, zero percent balance-transfer credit card, or 401(k) loan – may be the way to go.

Find out how much debt you owe and select the financing method that allows you to consolidate your debt with the least amount of risk.

Interested in tackling your debt with a second mortgage? To get started, learn more about home equity loans with Rocket Mortgage.

* Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.