Debt is rarely cheap, especially if it’s credit card debt. At 17.03%, the average interest rate on credit cards is at an all-time high and the bad news is, it’s expected to keep going up1. If you’re one of the many Americans with high-interest debt and have a home that you have built up equity in, it may be worth your time to consider consolidating debt utilizing your home’s equity.
There are two ways to tap into your home equity to pay off other debt: a home equity line of credit (HELOC) and a home equity loan. Below we walk through the pros and cons of consolidating your debt using these products so you can decide if it’s right for you.
The pros and cons of consolidating debt with your home’s equity
Benefits of debt consolidation with a HELOC:
- Pay less interest
- Currently, HELOC rates are currently around 6.00% and home equity loans are around 6.35%2. If you have high-interest credit cards, then consolidating with your home equity could save you money over time. Consider the following example
|Balance||Interest Rate||Annual Fee||Monthly Payment|
|Credit card 1||$12,000||15.05%||$95||$500|
|Credit card 2||$9,000||17.03%||$0||$400|
|Credit card 3||$5,000||19.00%||$0||$250|
|Total monthly payment||$1,150|
Home equity line of credit
Proposed interest rate: 5.99%
Loan term: 30 years
Estimated closing costs: $2,300
If you made the same monthly payment on your new loan (and didn’t spend any more) you could pay off your debt in just under two years (five months less than you could pay off your credit cards) and save $4,195 in interest payments.
- Can simplify your payments Every debt you have has a different payment and due date to keep track of, which can easily get overwhelming. Consolidating will cut down on the number of bills you have to track and pay each month.
- Easier to budget If you’re working on budgeting to take control of your finances, figuring out how much to pay on each debt every month in the smartest way can be tricky. Consolidating means you’ll have a single payment and due date, as well as a clearer picture of when you can be debt free.
- Can lower your monthly payments Using a home equity loan or HELOC spreads your payments out over a longer period of time, which translates into a lower monthly payment. This increases the amount of interest you ultimately pay, but provides more budgeting flexibility.
While there are clear benefits, there are some drawbacks too.
Drawbacks of consolidating debt with a HELOC:
- Could be easy to go deeper into debt
Similar to a credit card, a HELOC is a line a of credit. You can draw on the loan as much as you want up to the max limit. If you have issues setting and sticking to a budget, this access to cash could turn into a bigger problem.
- Often have strict requirements for approval
Lenders consider your credit score, debt-to-income ratio, the amount of equity you have in your home, and your history of paying bills to determine if you qualify for a loan. While requirements vary by lender, typically you will need a credit score of at least 620; a debt-to-income ratio of 43%; and at least 15% - 20% equity in your home. Some even require you maintain 10% - 20% equity after you take the loan.
- It costs money to get a new loan
Just like the mortgage on your home, both home equity loans and HELOCs often have fees. These costs can vary from lender to lender, but be prepared to pay for an appraisal, closing costs, and even origination fees. Some also charge an early closure fee; this is common if you are offered a loan with no closing costs.
- Interest rates may not be fixed
Typically home equity loan rates are fixed for length of the loan, but HELOCs are generally adjustable-rate loans. As you may be aware, interest rates have been going up and are on track to continue. So even if you get a HELOC at 6.0%, which is the average rate today, it could easily go to 7% by the end of the year.
- You could lose your house
Both HELOCs and home equity loans are secured loans, that is you put your home up as collateral. While this helps you get a lower interest rate, it also means if you default on your loan, the lender could take your house.
If you’re considering consolidating your debt with your home equity, consider a Figure’s Home Equity Line. Combining the best characteristics of traditional HELOCs and home equity loans, our unique home equity solution offers a fixed interest rate* and full access to your funds up front, while still enabling you to make additional draws once you’ve repaid your balance. Plus, you can get approved in five minutes and funding in five days**.*The Figure Home Equity Line is an open-end product where the full loan amount (minus the origination fee) will be 100% drawn at the time of origination. The initial amount funded at origination will be based on a fixed rate; however, this product contains an additional draw feature. As the borrower repays the balance on the line, the borrower may make additional draws during the draw period. If the borrower elects to make an additional draw, the interest rate for that draw will be set as of the date of the draw and will be based on an Index, which is the Prime Rate published in the Wall Street Journal for the calendar month preceding the date of the additional draw, plus a fixed margin. Accordingly, the fixed rate for any additional draw may be higher than the fixed rate for the initial draw.**Five-day funding timeline assumes closing the loan with our remote online notary. Funding timelines may be longer for loans secured by properties located in counties that do not permit recording of e-signatures or that otherwise require an in-person closing, or if the 5-day period includes a weekend or holiday.