If you have large outstanding balances on one or more credit cards, you may be struggling to bring your debt level down. It could take years—if not decades—to bring your cards back down to zero balance if you're only able to make minimum monthly payments. One alternative, if you own your home, is taking out a home equity loan and using the money to pay off your card debt. But before you do, you'll also want to consider the risks and some possible alternatives.
Key Takeaways
- A home equity loan is one way to pay off credit card debt.
- Home equity loans generally charge much lower interest rates than most credit cards do.
- The danger of a home equity loan is that you could lose your home if you are unable to repay it.
What Is a Home Equity Loan?
A home equity loan is a second mortgage. It allows you to borrow against the equity accumulated in your home over the years. It's based on the value of the home minus whatever is owed on your mortgage. For example, if you own a home that's currently worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.
Based on that, a bank, credit union, or other lender may be willing to issue a home equity loan equal to some percentage of your equity. You would need to apply for a home equity loan through the lender of your choice before anything else. How much you can borrow and whether you can get a loan at all will also be affected by other factors, such as your credit score.
Most lenders require borrowers to have some form of income, a credit score of 600 or more, and equity of at least 15% to 20% of the value of their home. You may qualify even if you don't meet these requirements but you will likely end up with a higher interest rate.
Unlike a refinance, this type of loan does not get factored into your mortgage. This means that you're taking on additional debt on top of your mortgage. As such, you will be required to make your monthly mortgage payment as well as the one to your home equity loan.
Many people take home equity loans to do repairs and renovations on their homes.
Advantages and Disadvantages of Paying Off Debt With a Home Equity Loan
Advantages
The principal advantage of using a home equity loan to pay off credit card debt is that you'll probably obtain a much lower interest rate than you are paying on your credit cards. For instance, the average interest rate on a home equity loan was 8.39% for the week of July 17, 2023, while the average credit card in Investopedia's database charged about 24%.
If you use a home equity loan to pay off multiple credit cards, it will also simplify your life, giving you just one bill to deal with each month instead of several.
One former advantage of home equity loans has been suspended, at least for some time. At one time, the interest you paid on a home equity loan was tax-deductible, while credit card interest was not. As a result of the Tax Cuts and Jobs Act (TCJA) of 2017, the interest on home equity loans is deductible only if you use the loan to "buy, build, or substantially improve" the home that secures the loan. That provision is slated to remain in effect at least until 2026.
Disadvantages
The major downside to taking out a home equity loan, whether that's to pay off debt or for any other purpose, is that you'll be putting your home on the line. Because your home serves as collateral for the loan, just as it does for your original mortgage, the lender could seize and sell it if you are unable to pay your loan back.
When you can't repay credit card debt, you'll also face serious financial consequences, of course, especially for your credit score. But because credit card debt is not secured by your home, you'll be at far less risk of losing it. Even if you have to declare bankruptcy because of your debts, you can often keep your principal residence.
As noted above, a home equity loan adds to your debt because it is a separate loan. This means that you must continue making your mortgage payment in addition to the loan payment each month.
Pros
Lower interest rate
One bill to pay off each month
Cons
Securing your loan with your home can be risky
May impact your credit score
Additional payment on top of your mortgage payment
Other Ways to Pay Off Credit Card Debt
A home equity loan is not your only option when it comes to paying off credit card debt. There are a few others you might consider.
Low-Interest Credit Card
Some credit cards allow you to transfer your balances over from other cards. This can make sense if you're able to obtain a significantly lower interest rate on the new card.
Many balance transfer credit cards also offer promotional periods of six to 18 months for which they charge 0% interest on the transferred balance. Of course, moving a balance from one card to another won't eliminate the debt. But it can help you pay it off faster—especially if you get a really great rate.
Debt Consolidation Loan
A debt consolidation loan from a bank, credit union, or other reputable lender could provide the money you need to pay off your credit card balances. This allows you to pool together a number of different debts into one. So if you have multiple credit cards, loans, or any other outstanding debts, you can get a larger loan to pay them off.
Debt consolidation loans tend to charge significantly lower interest rates than credit cards. And you also have the added benefit of making one monthly payment to a single creditor rather than many payments to different lenders.
Borrow From Your 401(k)
Many 401(k) plans allow you to borrow from the money you've accumulated in your account. If your plan comes with a loan provision, you may be able to borrow as much as $50,000. What's more, the interest you pay on the loan goes back into your account. Loans from a 401(k) do have a few caveats.
Keep in mind that you should only use this as a last resort. For one thing, the money you've pooled is intended for your retirement and should be kept for that purpose. If you withdraw the money, you'll lose out on compounding.
If you must use it, remember that the loan generally needs to be repaid within five years, or sooner if you leave your job. For another, if you're unable to repay the loan, it will be treated as a withdrawal, subjecting you to income taxes and a possible 10% penalty on the unpaid balance.
How Long Does It Take to Get a Home Equity Loan?
The process of getting a home equity loan, from application to approval, depends on a few factors. In general, it can take anywhere from a couple of weeks to a few months. The process could go smoothly and quickly if you're prepared with all the required paperwork. But there may be certain holdups that are beyond your control, including the underwriting process, the timing of the appraisal, and the closing.
Should I Get a Home Equity Loan or Refinance?
This depends on your personal and financial situation because a home equity loan is completely different from refinancing. A home equity loan is an additional loan on top of your existing mortgage. This means if you're approved for the loan, you have to make both payments each month. The loan does give you additional cash to do whatever you wish, whether you want to renovate or pay off other debts. Refinancing, on the other hand, means you restructure the original mortgage debt with new terms. In some cases, you may be able to refinance and add the value of additional equity into your new loan.
How Can You Use a Home Equity Loan?
Home equity loans can be used for any purpose. If you meet your lender's requirements and are approved, you can use the money to make improvements or repairs to your home, pay off other debt, or pay for other expenses. Keep in mind that you must make your monthly mortgage payment in addition to the one for your loan.
The Bottom Line
A home equity loan can be a good way to pay off high-interest credit card debt as long as everything goes according to plan. In deciding whether it's a viable option, consider how strong—or precarious—your financial situation currently is. If you have a secure job (and/or a spouse with one) and are confident that you'll have no trouble keeping up with the payments, it could make sense. However, if your job is on shaky ground and you have no other financial resources to draw on if you lose it, a home equity loan could be a risky proposition. Remember, it can cost you your home in the worst-case scenario.
