A home equity line of credit (HELOC) offers flexible access to cash, using your home as collateral. Getting a HELOC for debt consolidation could be attractive if you can qualify for a low interest rate, and want to streamline your monthly budget. Using a HELOC or its cousin, a home equity loan, for debt consolidation has both pros and cons, and it’s helpful to weigh both sides when deciding if it’s the right move.
Table of Contents
- Key Points
- • Using a HELOC for debt consolidation can lower payments and interest by combining multiple debts.
- • The main risk is converting unsecured debt (like credit cards) to secured debt, putting your home at risk of foreclosure in the event of default.
- • HELOCs have variable rates, meaning payments and total interest can change.
- • To qualify, you generally need good credit, steady income, a low debt-to-income ratio, and adequate home equity.
- • Responsible use is vital: Borrow only what’s needed, make full payments, and avoid incurring new credit card debt.
What Is a HELOC?
A HELOC is a revolving credit line that’s secured by your home. Your lender may offer access to your credit line via a debit card, credit card, or paper checks. As you withdraw from your credit line, your available credit shrinks; you free up credit as you pay down the balance.
HELOCs typically have a draw period and a repayment period.
• During the draw period, which may last 5 to 10 years, you can use your credit line. You’ll be expected to make payments each month, but typically only interest payments are required. If you repay all that you owe you can draw from the full credit line again.
• Once the draw period ends, repayment begins. You’ll make principal and interest payments for the remaining loan term, which may be anywhere from 5 to 20 years.
A HELOC may have a fixed or variable interest rate, though variable rates are more common. Some HELOCs take a hybrid approach and offer a low, fixed rate for a set period before switching to a variable or adjustable rate. Your ability to qualify for a HELOC depends on your credit scores, income, debt, and how much equity you’ve built up in your home.
Can You Use a HELOC to Consolidate Debt?
Can a HELOC be used for debt consolidation? Yes. In fact, it’s one of the more common uses for a home equity line of credit. Many lenders market their HELOC products specifically to borrowers who want to use their equity to combine and pay off other debts.
Here’s how HELOC debt consolidation works:
• You’re approved for a HELOC with a set credit limit.
• You use your credit line to pay off other debts, like credit cards, medical bills, or personal loans.
• Once you’ve paid off those debts, you make one monthly payment to your HELOC until it’s paid off.
You can use a HELOC to consolidate most types of debt, including student loans. Is a HELOC a good idea for debt consolidation? It can be for some homeowners, but every situation is different.
Benefits of Using a HELOC for Debt Consolidation
Getting a HELOC for debt consolidation has its advantages. Here’s why you might consider this strategy to pay off debt.
• Fewer payments: Using a HELOC or a lump-sum home equity loan for debt consolidation can reduce the number of debt payments you have to make each month. That can make budgeting less of a hassle.
• Smaller payments: Combining debts with a HELOC could also result in a lower monthly payment overall. You could use the extra money in your budget to fund other goals, like saving for retirement or building an emergency fund.
• Interest savings: If your new [HELOC interest] rate is lower than what you were paying to the debts you consolidated, you could save money on interest. How much you save, if anything, is contingent on the rate and HELOC term.
A home equity line of credit also offers flexibility. While you might be interested in a HELOC for debt consolidation, there are other ways you could put it to work. You could use your credit line to make home improvements or repairs, cover an emergency situation, or fund large planned purchases.
Risks and Considerations
Can a HELOC be used for debt consolidation? Yes. Should you use a HELOC to consolidate debt? There are some risks to be aware of.
• Secured versus unsecured debt: Credit cards, personal loans, and medical bills are typically unsecured debts, which means they aren’t tied to any collateral. You could be sued for them if you fail to pay, but a creditor would have to work really hard to take your home for those debts. When you use a HELOC for debt consolidation, unsecured debts become secured and tied to your home. It is easier in this situation to foreclose if you fall behind on payments.
• Interest unpredictability: A fixed-rate HELOC can offer predictable payments and interest costs, but they’re less common than variable-rate HELOCs. With a variable rate, the interest rate can go up or down, affecting both your monthly payment and your total interest costs over the loan term.
Using a HELOC to consolidate debt could also put you at risk of creating new debt if you’re making new purchases with paid-off cards, or taking out additional personal loans. Borrowers generally need discipline and self control to make a HELOC for debt consolidation work.
HELOC vs Other Debt Consolidation Options
If using a HELOC or home equity loan for debt consolidation doesn’t appeal to you, or you’re unsure you can get approved, you may have other options. Here are some HELOC debt consolidation alternatives you might consider.
• Personal loans: A personal loan gives you a lump sum of money that you can use for virtually any purpose, including debt consolidation. The best [debt consolidation loans] have low, fixed rates and generous borrowing limits. With SoFi personal loans, for example, you could borrow up to $100,000 to consolidate debt.
• Balance transfer: Balance transfer credit cards let you move balances from one card to another, usually to get a lower or 0% APR. You could save on interest if you pay the balance in full before the promotional rate period ends. Just watch out for balance transfer fees, which can range from 3% to 5% of the amount transferred.
• 401(k) loan: If you have a 401(k) at work, you might be able to borrow against it. The upside is that 401(k) loans have low interest rates, and you’re paying the money back to yourself instead of a lender. The downside, however, is that you reduce the amount of money that grows for your retirement and if you don’t pay the loan back within five years (or immediately after leaving your job) the entire amount is treated as a taxable distribution by the IRS.
• Cash-out refinance: Cash-out refinancing replaces your current mortgage with a new, larger one, and allows you to pull your equity out in cash at closing. You might prefer a cash-out refinance to a HELOC or home equity loan if you’d like to have just one mortgage payment to make each month instead of two.
A debt consolidation calculator can help you estimate your savings from combining multiple debts. If you’ve fallen behind on debt payments or at risk of falling behind, you may need to look into a debt management plan (DMP) or debt settlement. A credit counselor can evaluate your debt situation and offer advice on which strategy might be best for you.
Recommended: Refinance Your Mortgage and Save
How to Qualify for a HELOC
HELOC requirements vary by lender but generally extend to the same set of factors. Lenders typically want to see that you have solid credit scores, steady income, low debt levels, and sufficient equity in your home.
• Credit scores: The minimum credit score needed for a HELOC depends on the lender. It’s not unusual to see lenders require a score of 680 or higher, though you may be able to get a HELOC with a score below that mark.
• Income: Lenders may or may not specify a minimum income you need to have to get a HELOC. The main concern is that any income you do have is consistent, reliable, and enough to allow you to afford HELOC payments.
• Debt-to-income (DTI) ratio: Your DTI ratio measures how much of your gross pay goes to debt repayment each month. A DTI of 45% or less is often the sweet spot for HELOC approval, though some lenders may approve you up to 50%.
• Equity: Lenders require you to have more than 15% to 20% equity in your home in order to qualify. Your equity is your home’s value minus whatever you still owe on your mortgage. Divide the answer by the home value to get your percentage equity.
Getting prequalified with multiple lenders can give you an idea of what you’re likely to be approved for. Prequalification isn’t a guarantee of approval, but it’s a way to get perspective on available interest rates, HELOC amounts, and terms, based on your credit profile. That can help you decide whether a HELOC fits into your budget.
How to Use a HELOC Responsibly
If you plan to get a HELOC for debt consolidation, it doesn’t hurt to have a strategy for using it. Here are some tips to help you make the most of your HELOC responsibly.
• Calculate how much you need to consolidate your debts, and borrow only that amount.
• Pay off your debts as soon as your lender gives you access to your credit line, or look for a lender that offers direct payment to creditors.
• Make full payments, rather than interest-only payments, during the draw period if your lender allows it.
• Check your HELOC terms to find out if the lender charges a prepayment penalty if you pay your credit line off before the loan term ends.
• Avoid making new purchases on the credit cards you’ve paid or, or with your HELOC, to keep your debt to a minimum.
It’s also important to calculate the cost of using a HELOC for debt consolidation. If it would cost you more in interest and fees to consolidate debt with a home equity line of credit, versus using another debt consolidation option or a DIY debt repayment method, then it may not be worth it in the long run.
Recommended: Differences in a HELOC vs. Home Equity Loan
The Takeaway
Using a HELOC or home equity loan for debt consolidation could help you get ahead financially, but it’s important to research borrowing options carefully. A HELOC could be a temporary fix if your budget is weighed down by debt payments, but you may create new headaches for yourself if you’re not using your credit line responsibly.
SoFi now partners with Spring EQ to offer flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively lower rates. And the application process is quick and convenient.
FAQ
Is interest on a HELOC tax deductible for debt consolidation?
Interest on a HELOC is typically not tax deductible for debt consolidation. Tax rules around deduction of HELOC and home equity loan interest are complex and can depend on the tax year and how funds were spent. It’s best to consult a tax advisor about your specific situation.
How much can I borrow with a HELOC?
The amount you can borrow with a HELOC depends on how much equity you have in your home, your credit scores, income, and debt. Lenders may cap the amount you can borrow, either as a percentage of equity or a set dollar amount. SoFi, for example, offers home equity loans up to 90% of equity or $500,000.
Will using a HELOC hurt or help my credit score?
Getting a HELOC can hurt your credit score initially since the lender will likely perform a hard credit check when evaluating your application. However, using a HELOC for debt consolidation or any other purpose could help your credit scores over time if you’re making payments on time and reducing your overall debt load.
How long does it take to get a HELOC?
The speed at which you can get a HELOC depends largely on the lender. Some lenders may offer same-day or next-day approval, followed by an underwriting period that can take a few weeks to complete. Once underwriting is finished, you’ll head to closing and after that, you may have access to your credit line within a 1 to 3 business days.
Is it a good idea to use a HELOC to consolidate debt?
When used responsibly, a HELOC could be a good way to consolidate debt if you can get a lower interest rate than what you’re paying now. The risk with using a HELOC for debt consolidation is what can happen if you fall behind on payments. In a worst-case scenario, you could end up in foreclosure and lose the home for an unpaid HELOC debt.
Photo credit: iStock/Tinnakorn Jorruang
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