Using Home Equity To Pay Off Debt: Is it Smart?

The longer you make payments toward your mortgage across the loan term, the more equity you'll build up in your home. 

If you have other outstanding loan amounts or lines of credit dragging down your credit score and causing financial difficulties, it might be tempting to use home equity to pay off debt. But is it wise to do so? 

This guide will help you consider whether using home equity to pay off debt is a good idea for your financial situation.

What Is Home Equity?

Home equity is your ownership stake in your property. You build up equity by making a down payment, improvements that increase the value off the home, and regular mortgage payments.

For example, if your house is worth $500,000, and you’ve paid off $250,000, then you have 50% equity in the property. The lender has the other 50% stake. Home equity is, in effect, a kind of cash reserve you can sometimes dip into through various home equity loans, investments, and lines of credit.

Can You Use Home Equity To Pay Off Debt?

Yes, you can use home equity to consolidate debt. This can increase your cash flow on a monthly basis and help rebuild credit scores.

Some examples of debts you can pay off with equity include:

• Credit card debt, including balance transfer credit card debt
• Personal loans and business loans through debt consolidation
• Medical expenses
• Payday loans
• Tax liens
• Your mortgage balance on a second mortgage
• Closing costs for a mortgage deal or foreclosure fees
• The balance of a debt consolidation loan
• Any other high-interest debt you may have

Many people use equity to pay for home improvements, which also increases the market value of their properties. In this way, they build up equity while spending equity simultaneously: quite a handy personal finance trick.

How Can You Use Home Equity To Pay Off Debt?

When you contact a home equity investor, you sell the equity to them in exchange for cash. Alternatively, you can use your home equity as collateral for a loan from a different lender (or from your same mortgage lender if you are on good terms with them).

Regardless, you can use your home equity to pay off debt in a few different ways: 

• You can take out a home equity loan, using the proceeds to pay your other debt.
• You can open up a home equity line of credit or HELOC. This works like a regular credit line that you dip into it when you need to, then pay it off over a period of time.
• You can use a cash-out refinance. In this type of transaction, the current loan is paid off in full. The new loan will include the original loan balance plus any cash out and closing costs that come with the refinance. In some cases the loan can have a lower interest rate but will always have a higher balance since you are trading equity for cash.
• You can involve a home equity investor like Balance, who pays you for your home’s equity and a percentage of future equity appreciation. Balance helps homeowners not only access cash to consolidate debt, but also helps them build their overall financial profile and repair their property.

Any of the methods listed above can potentially allow you to use the equity in your home to pay off various debts, like credit cards, personal loans, student loans, medical bills, and more.

While there are a few cons of using home equity, these are generally minor compared to the penalties for missing high-interest credit card payments or making other poor financial decisions.

When Might You Use Home Equity To Pay Debts?

While using home equity to pay off your debts is possible, you may wonder whether you should. There are a few times when it might be a good idea to use home equity to pay off debt.

You Have a Lot of Home Equity Built Up

If you have a lot of home equity because you have been making regular mortgage payments for several decades, all that money can be put to work to pay off your existing debt. 

You can always build equity back up again, but the regular debt will drag on your credit score and negatively impact your finances, this strategy may be one of the best ways to maximize your financial health in the short term and long term at the same time.

You Need To Pay Off Debt Fast

If you need to pay off a debt quickly, home equity could be a solution. If you use a cash-out refinance to get a lump sum based on your house's equity, for example, you can pay off an immediate medical bill or other debt that would otherwise result in financial catastrophe.

Your Equity Can Fully Cover Your Debt Amount 

Generally speaking, it's only a good idea to use home equity to pay off debt if the equity in your house can cover your debt amount. 

Using equity to consolidate debt can show as a green flag to future lenders because consolidation can both lower your debt to income by lowering your monthly obligations and help build credit. This is one of the most significant pieces of advice a credit counseling specialist will give you.

By paying off your debt, if you go to refinance or get other loans in the future, you can qualify for better loans. 

Co-Ownership With Balance

Balance Homes is a co-ownership solution with a mission to help American homeowners stay connected to the homes they love by offering a flexible alternative to traditional financing when life circumstances change. Our model also focuses on long-term financial health and education, helping homeowners understand their options, manage their equity, and build a plan that fits their needs.

Ready to get started? Get your free proposal today.

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Sources:

Understanding your home's equity | Freddie Mac

collateral | Wex | US Law | LII / Legal Information Institute

What is a home equity loan? | Consumer Financial Protection Bureau

What Is a Cash-Out Refinance? | Experian