Whether you’re facing emergency expenses, home renovations or credit card debts, a home equity line of credit (HELOC) could be the right move for you (with the key word here being could). A HELOC for debt consolidation puts all your debt into one place while allowing you to borrow the money from yourself. However, heavy clauses could do more harm than good, depending on your financial situation. But before considering this route, know that most lenders require a credit score of at least 620.
What is a HELOC for Debt Consolidation?
With a HELOC, a homeowner taps into their home's equity (the difference between the market value of the home and the amount they owe on their mortgage) and borrows against it like a line of credit. They can take however much they need and use it for any purpose. You’re compiling all your debts into one payment for a HELOC for debt consolidation.
“At closing for a HELOC, either the closing company pays off the unsecured debt or the borrower draws from the HELOC shortly after closing to pay off other debts,” says Ashley Morgan, attorney and owner at Ashley F. Morgan Law, PC.
When the draw period ends and the repayment period of a HELOC begins, the homeowner has a set amount of time to repay the full amount borrowed, as well as interest. The only people who should move forward with a HELOC for debt consolidation are those who are extremely confident that they can meet the monthly payments.
“A HELOC can be dangerous,” warns Morgan. “If you miss payments on a HELOC, the bank can foreclose. It doesn’t matter if you have a current first mortgage; a HELOC is basically a different type of second mortgage.”
Pros of Using a HELOC for Debt Consolidation
Once you know your equity amount, you can borrow as much or as little as you’d like. Plus, a homeowner’s monthly payments will be noticeably lower when using a HELOC for debt consolidation than if they kept their debts where they were.
“The payment is lower on a HELOC because it is interest-only [for some] – usually for the first three to 10 years,” says Dre Torres, loan officer at Cornerstone First Mortgage. “You can leverage a lot more money for a much lower payment. That is when it makes the most sense to eliminate high-interest debt coupled with high monthly payments.”
Cons of Using a HELOC for Debt Consolidation
Although the monthly payments are typically lower, you may be subjected to a higher interest rate than a traditional mortgage. After all, the credit lender is taking on a higher risk with it being a second mortgage.
“Most HELOCs have a cap on them, but many of those caps in today's market are around 17% on average,” says Torres. Some HELOCs for debt consolidation are interest-only initially and include both the principal and interest. Be sure that you’re prepared for that jump when it happens.
Although a HELOC for debt consolidation is a type of second mortgage, you typically won’t get a 30-year repayment window like you do with the first. That time period is shorter because, again, the creditor is taking on the risk. And if you miss payments, the bank could foreclose on your home no matter how up-to-date you are on your original mortgage.
Alternatives to Using a HELOC for Debt Consolidation
Before deciding if a HELOC for debt consolidation is right for you, consider an unsecured consolidation loan, bankruptcy and debt settlement as alternate routes.
Morgan says, “An unsecured consolidation loan works similarly to a HELOC, but it isn’t secured against your property. As a result, the unsecured loan usually has a higher interest rate. It can still be lower than credit cards after an interest rate, but not as low as a HELOC.”
The word “bankruptcy” can be scary, but it’s a viable option for some. A Chapter 13 could restructure the debt with a three- to five-year payment plan, while a Chapter 7 could eliminate the debt. Keep in mind that not all debts are covered. For example, Chapter 13 won’t include debts from student loans, spousal or child support or back taxes.
A third option is debt settlement, in which you negotiate with your creditors to pay back less than what you actually owe.
Why You Should Trust Us
About 25 million readers turn to Benzinga each month and that’s because we’re a leading trusted outlet covering financial markets, corporate and economic data and actionable trading ideas. Since 2010, our goal has been to help readers feel confident in their financial decisions. For this story, we spoke with Ashley Morgan, attorney and owner at Ashley F. Morgan Law, PC, who handles bankruptcy, corporate and tax resolution cases and Dre Torres, loan officer at Cornerstone First Mortgage.
Caitlyn Fitzpatrick, the author of this piece, has been an editor and writer since 2014. She started her career at a medical magazine, where she attended conferences around the world to interview physicians about their scientific studies. Since then, she’s been in the commerce journalism world to help readers make smart buying decisions. Fitzpatrick prides herself on taking complex topics and breaking them into digestible pieces.
FAQ
Is using a HELOC to consolidate debt a good idea?
The answer differs from homeowner to homeowner, so discussing your case with a financial expert or lawyer will shed light on your situation. Torres says that those planning to pay it back within 12 to 36 months should consider a HELOC for debt consolidation, as your payments will be lower and the market will (hopefully) improve. To be sure you can do that, remember that once the interest-only term is up, you’ll be paying both principal and interest.
“Once you use the HELOC for debt consolidation, there is no going back until the HELOC is paid off. While people use the HELOC as a tool to make paying your debt off easier, I always advise clients to prepare for the worst,” says Morgan.
Does debt consolidation negatively affect credit score?
Saying goodbye to your debt positively impacts your credit score. However, if you’re utilizing a high amount of the HELOC for debt consolidation, it could slightly negatively impact your credit. Torres suggests keeping your credit utilization ratio below 30% to prevent this. But in general, your credit score will skyrocket within a few months of paying off those debts.
What kind of debt should you consolidate using a HELOC?
Focus on debts with a high interest attached to them, such as credit card debt and personal loans with more than one year remaining. “Leveraging a HELOC will still give you better terms than 99.99% of credit card companies,” says Torres. “The average credit card debt is 27% and you can roll that into 10% to 11% in a variable interest rate on a HELOC, which will improve with the market.”
Sources
- Ashley Morgan, attorney and owner at Ashley F. Morgan Law, PC
- Dre Torres, loan officer at Cornerstone First Mortgage
- United States Courts
About Caitlyn Fitzpatrick
Caitlyn Fitzpatrick has been a professional writer and editor since 2014 and entered the commerce journalism world in 2017. She’s passionate about helping readers make smart buying decisions by using data insights and interviewing experts. Most recently, Fitzpatrick was the Senior Shopping Editor at Trusted Media Brands, where she led affiliate content on Reader’s Digest. In addition to Benzinga, Fitzpatrick’s work can be found in a range of publications, including U.S. News & World Report’s 360 Reviews, Today’s Parent, Betches, WhatToWatch.com, PS (formerly Popsugar), and more.