Many American homeowners are juggling a mix of credit cards, medical bills, and personal loans simultaneously. If you’re feeling overwhelmed by the payments, you may consider using a home equity line of credit (HELOC) to pay off debt.
Before you apply, here’s what you should know about this strategy, including how it works, its pros and cons, and when it may be a good idea.
What Is a HELOC?
A HELOC is a line of credit based on your home equity. Home equity is the gap between what your home may be worth and what you still owe on your mortgage.
A HELOC works similarly to a credit card. You can borrow up to a set limit during a “draw” period, then pay it back over time. Interest is charged only on what you use, not the full limit. Still, it’s a home-backed loan, so defaulting could cost you your home.
Can You Use a HELOC to Pay Off Debt?
HELOC terms typically let you use your funds to pay off existing debt. This can be an effective way to roll balances into one monthly payment, known as debt consolidation.
Why Use a HELOC to Pay Off Debt
Credit cards often carry high rates, so a HELOC may appear to offer savings. It can also consolidate your bills, allowing you to focus on paying one lender instead of juggling several different due dates and payment amounts.
In addition, you’re often allowed to make interest-only payments during the initial draw period, which can last for several years.
Common HELOC Risks and Pitfalls
HELOCs can be valuable financial tools, but they also have some significant risks to consider:
- Your home is on the line. If you fail to pay back your HELOC, the lender may take steps to foreclose on your home.
- The rate may change. Many HELOCs use a variable rate, so your finance charges can increase if interest rates rise.
- Payments can jump quickly. During the draw period, payments are often interest only. Once the dedicated repayment term starts, the required payment can rise significantly.
- Paid off debts can return. Paying off debt with a HELOC doesn’t stop you from accumulating more. You could end up with a HELOC balance and fresh credit card debt.
HELOC vs. Home Equity Loan for Debt Consolidation
Some people compare a HELOC with a home equity loan for the same goal. While they both let you borrow against your residence, they have very different structures.
A home equity loan usually gives you a lump sum with a fixed rate. Payments are often steady, which can feel easier to plan around. A HELOC may offer more flexibility early on since you can borrow only what you need and make interest-only payments for a time. However, the rate is often variable and may increase over time.
Debt Consolidation Loan vs HELOC
Another common comparison is a traditional debt consolidation loan vs HELOC. Once again, there are pros and cons to both.
A debt consolidation loan is often unsecured, so it doesn’t tie the balance to your home. However, the rate may be higher as a result, depending on the lender and your credit profile. It’s also a type of installment debt, like a home equity loan.
Should You Use a HELOC to Pay Off Debt?
A HELOC may make sense for paying off debt when you’re replacing higher-interest balances with a lower-rate option. This is most common with credit cards or personal loans that carry significantly higher interest rates.
It tends to work best if you have steady income and enough equity to borrow responsibly. Because HELOC rates are often variable, you need room in your budget if payments increase over time.
A HELOC is generally riskier if it’s used without a clear payoff plan. Turning unsecured debt into debt backed by your home raises the stakes if spending habits don’t change or repayment stretches out longer than expected.
Costs and Terms to Review
In addition to variable interest rates, HELOCs carry fees, such as closing costs, appraisal fees, or annual fees. Terms vary by lender, so read your offer details carefully.
In addition, pay attention to the specifics of your withdrawal and repayment periods. In the first, you generally need to make interest-only payments toward your debt. In the second, you’ll have to repay what you owed on a fixed schedule.
It’s also important to know whether you’ll have the option to freeze your credit line. Some HELOC agreements allow that under certain conditions.
Final Thoughts
Using a HELOC to pay off debt can lower your interest costs and simplify payments, especially during the initial withdrawal phase. However, it can also raise the stakes by tying your debt balances to your home.
Before committing to a HELOC, compare it against alternative debt relief options, such as home equity loans and unsecured debt consolidation loans. If you’re not sure what makes sense for you, consider speaking with a credit counselor or other financial expert.
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