If you have equity in your property, a home equity loan may help you pay off credit card debt faster. This type of loan typically comes with a lower annual percentage rate (APR) than most credit cards and allows you to consolidate all your payments into one.
In mid-January 2023, starting rates on home equity loan APRs were as low as 3.99% while the lowest credit card APRs bottomed out at 18.99%.
While a home equity loan may not be the best solution for everyone, it’s an option worth considering if you’re struggling with high credit card debt. You do have to post your home as collateral, which adds a significant risk, so it’s important to carefully consider whether a home equity loan would work for your situation.
- What are home equity loans?
- Using a loan to pay off your credit card
- Loan limitations
- Alternatives ways to pay off credit cards
What are home equity loans?
A home equity loan is similar to a personal loan but rather than borrowing from a lender, you borrow against the equity you have in your home. Equity is the amount your property is worth minus your outstanding mortgage amount.
For instance, if your home is worth $350,000 and you have $250,000 left on your mortgage, you have around $100,000 of equity. Most banks offer home equity loans as a lump sum with a fixed interest rate. Once you receive your loan, you’ll make fixed monthly installments throughout your loan term.
If you’re unable to repay your loan, the lender can seize the collateral — your home. Home equity loans may include upfront fees with the repayment term usually ranging from five to 20 years.
Another type of home equity loan is a HELOC, which stands for home equity line of credit. With a HELOC, you still borrow from your home’s equity. However, instead of receiving a lump sum payment, you can draw against a line of credit over a fixed length of time.
Similar to a credit card, the lender approves you for a certain amount of credit. HELOCs have a draw period where you can borrow money from your credit limit as needed. Afterward, you’ll enter a repayment period where you must pay back the amount you used.
How to use a home equity loan to pay off your credit card
If you have balances on multiple credit cards, a home equity loan can help you consolidate your payments and simplify the process of paying off your debt. Instead of having to keep track of several different due dates, you’ll only have one to remember.
Also, home equity loans usually come with lower interest rates than your credit cards. You can use the lump sum payment to pay off all your credit card debt at once, which will save you money on interest over time.
How to get a home equity loan
You can apply for a home equity loan with a bank, credit union, or mortgage company. Here, we outline the five steps needed.
- Check your credit. Each lender will have its own credit-score requirements, but generally, you’ll want to make sure your credit score is high enough to help you qualify for a low rate and good terms. Start by requesting your credit reports via AnnualCreditReport.com, disputing any errors with the appropriate bureaus (Equifax, Experian and TransUnion), and monitoring your scores, perhaps via your current financial institutions.
- Contact your current lender first, but shop around. Always start with your current mortgage lender to see what they would offer based on the equity you have in your home. Then reach out to other reputable lenders and compare their offers and rates.
- Submit an application. Once you feel confident with a lender’s home equity loan option, submit an application, which can usually be started online. The application will include details about your existing mortgage, monthly income, and other debts. Some financial institutions have loan officers that can walk you through the application process over the phone.
- Upload supporting documents. When you submit your application, you’ll need to provide documents such as your recent pay stubs, W-2 forms, tax assessment, and proof of homeowners insurance. At this time, the loan application will go into underwriting.
- Read loan papers carefully before signing. You’ll receive the final terms when the loan’s approved. Carefully review these terms and ask for clarification if there’s anything you don’t understand. Under most circumstances, you still have three days to cancel after signing the loan paperwork under the Federal Three-Day Cancellation Rule.
Loan limitations
Lenders generally require that you borrow no more than 80% of the equity in your home. To calculate your home’s equity, take the current appraised value of your home and subtract it by the remaining balance on your mortgage.
current appraised value – mortgage balance = equity
For example, for a $450,000 property with a $200,000 mortgage, you’d have $250,000 in home equity.
These same numbers are used to determine your LTV or loan-to-value ratio. Your LTV ratio equals your current loan balance divided by the current appraised value of your home. A higher LTV ratio could increase your borrowing costs since banks view this as more risky.
Alternatives to home equity loans for credit cards
Other options exist to help pay off your credit cards if you don’t want to put your house up as collateral.
- Debt consolidation loan: This is a type of personal loan that helps you combine all your credit card balances into one loan with one monthly payment. Debt consolidation loans help you simplify your monthly payment and can often lower your interest rate.
- Balance transfer credit card: With this type of financing, you transfer your existing credit card balance to the new card and get a 0% APR for a promotional period. With a 0% APR for a months long period (sometimes as many as 18 or 21 months), you can focus on paying off just the principal balance. This strategy really only makes sense if you can afford to zero your balance before the introductory 0% APR expires. Also, some cards charge a balance transfer fee so be sure to factor this into your potential savings.
- Cash-out refinance: A cash out refinance loan is where you refinance your mortgage by replacing your current loan with a new, larger balance. Then, you can take the additional funds out as cash once you close on the new loan. A cash out refinance can help you access a lump sum to pay for major expenses or pay down debt. Just keep in mind that you’ll need to pay closing costs similar to your original mortgage.
- Personal loan: Personal loans are usually unsecured, which means they don’t require any collateral. Banks, credit unions, and online lenders offer personal loans with competitive interest rates and flexible terms. Some loans have upfront fees and typically, you have anywhere from 12 to 84 months to repay the loan.
- 401(k) loan: A 401(k) loan allows you to borrow money from your retirement account, but you must pay it back overtime, plus interest. One advantage here is that both the loan and interest payments go back into your 401(k) account.
Pros and cons of using home equity loans for credit card debt
Consider the advantages and disadvantages of home equity loans before proceeding.
Pros:
- One fixed monthly payment
- Potentially lower interest rate
- Pay off all your credit card debt at once
Cons:
- You need to put up your home as collateral
- Some upfront costs such as an origination fee
- Need to have enough equity in your home
Should you use a home equity loan to pay off credit card debt?
If you have enough equity in your home and are confident you can pay off the home equity loan on time, you may be able to secure favorable loan terms and get out of debt faster.
However, a home equity loan may not be your best option. If you plan on selling your home soon or worry that you can’t afford your loan, it’s better not to risk it. While paying off credit card debt sooner makes financial sense, it’s not worth losing your home over. So you may want to consider some of the alternatives mentioned above.