Should You Use Home Equity to Pay Off Debt?
Home Equity for Debt Reduction
You’re staring at a mountain of debt and wondering how to pay it all. Bills keep piling on, but your payments, especially today, barely make a dent in your situation. Sure! You’ve heard of refinancing your home; some use home equity to tackle their mounting debt. But is it a good idea? And, if so, what must you know before diving in?
We understand your situation. It’s a common theme for many, which is why we’re here to help. Debt is no fun. It’s often downright stressful and frustrating, but there is a way out. As for using your home’s equity to pay down or pay off debt? Let’s go over the finer details first. Then, you can judge whether paying off debt with home equity makes sense for your situation.
What is Home Equity?
Many believe home equity is the amount of money you’ve paid on your home loan. While there is truth to this, home equity goes further, factoring in the current housing market and your home’s value.
Home equity is your home’s current market value minus any outstanding lien (or loan). So, if your home value is $500,000 and you still owe $250,000 on your mortgage note (and have no additional liens), then you can reasonably expect to have $250,000 in home equity.
Should You Use Home Equity for Debt?
Home equity is a viable option to pay down or pay off outstanding debt. However, whether that’s a good idea depends on a few things.
- How much debt do you have?
- How do you access your equity?
- What is the interest rate for a home equity loan the lender offers?
- What would the new mortgage payment be?
How Much Debt Do You Have?
If you have minimal outstanding debt, using your home equity to pay it off might not make sense. To access home equity, you’re essentially increasing the debt you owe and extending how long it’ll take you to pay it off.
However, if you have a lot of debt, vast amounts of or high-interest debt, then accessing home equity might make sense. It’s a great way to quickly eliminate this debt and give you more breathing room in your finances. Remember, there’s always a trade-off when you access home equity.
How to Access Home Equity for Debt
There are a few ways to access home equity, and each differs from the next.
- Refinance
- Cash-Out Refinance
- Home Equity Loan
- Home Equity Line of Credit (HELOC)
Refinance
A standard refinance does not provide cash back for debt or anything else. It’s essentially replacing your current home loan with a lower interest rate loan, lower monthly payment, or for a new loan term. However, it’s worth mentioning because it’s sometimes confused with our next option: cash-out refinance.
Cash-Out Refinance
A cash-out refinance works like a standard refinance, except it also gives you access to your home’s equity, which allows you to get cash back from the refinance.
Generally, most lenders will only allow you to draw out up to 80% of your home’s value, which includes the amount of home loan you still owe.
Home Equity Loan
A home equity loan is another option. However, this option lets you take out a loan against your available home equity without having to refinance. Home equity loans are often more attractive than personal loans since they tend to offer lower interest rates for borrowers.
In essence, these loans are a type of second mortgage. The downside is that your home is collateral until you fully repay this loan. So, be mindful of what you can and can’t afford in your budget. A home equity loan might be a good option if your loan payment is equal to or less than what you currently pay on your debt.
Home Equity Line of Credit
A home equity line of credit (HELOC) is like a home equity loan. However, a HELOC allows you access to a certain amount of money, up to the amount you’ve been approved for, that you can use as needed. Once approved, you’re only responsible for repaying the amount of credit you use plus any interest rate your lender charges. For example, you’re approved for a $30,000 line of credit, but you’re only required to pay back the $20,000 (plus interest) you accessed to pay off your debt.
The Final Word
Home equity is a great way to eliminate debt, but not all debt or every situation makes sense for you to tap into it as a source of funds. Remember, you’re still trading one form of debt for another when using home equity. So, you’ll still pay for all the debt. However, if you have a lot of debt or high-interest debt, then using home equity can help. You’ll consolidate that debt and reduce the amount you’re paying in interest.
Do you have more questions about home equity? Give us a call! We’re happy to guide you in making the best decision.
Sources
- https://www.investopedia.com/terms/h/home_equity.asp
- https://themortgagereports.com/68932/cash-out-refinance-guide-rules-rates-requirements
- https://www.bankrate.com/home-equity/what-is-home-equity-loan/#how-it-works
- https://www.kiplinger.com/real-estate/mortgages/602259/things-to-consider-before-you-refinance-your-mortgage
- https://www.bankrate.com/mortgages/cash-out-refinancing/
- https://www.cnbc.com/select/pros-and-cons-of-refinancing-home/
