If you’re looking to consolidate debt, you’ve got a few options. You could apply for a debt consolidation loan, move your debt to a balance transfer credit card, or ‒ if you have significant equity in your home ‒ take out a home equity line of credit (HELOC).
A HELOC is a line of credit that is secured against the current equity you own in your home. Typically, lenders want to see that you’ve got at least 20% equity before approving you for any kind of home equity loan or line of credit. To figure out how much equity you own, divide how much of your mortgage you’ve paid off by the total value of your home.
HELOCs function much like a credit card, in that they’re a revolving line of credit. Your maximum limit is determined by how much equity you have, and you can borrow as much or as little money as you’d like, as long as you stay within this limit. Because it’s not a loan, you won’t pay interest on untapped funds.
Home equity credit lines are most commonly used for home renovations, but they can also function as a tool for debt consolidation. Because you are offering up your home as collateral, it’s in your best interest to understand the pros and cons of using a HELOC before applying for one.
<h2>Pros of using a HELOC to consolidate debt</h2>
One of the most attractive aspects of any kind of debt consolidation plan is streamlining your payments. If you use your HELOC to consolidate your other debts into one monthly payment, tracking and paying them on time becomes easier. Simplifying your finances can help you avoid unnecessary late fees.
Because your HELOC is secured against your home, you’re likely to see an interest rate much lower than that of a traditional unsecured line of credit or loan. Lenders are more comfortable knowing that such an important and valuable piece of collateral has been offered up. By consolidating your other debts into a low-interest HELOC, you could potentially save yourself quite a bit of money by effectively bypassing higher interest rates on credit cards and other unsecured loans.
A HELOC occurs in two phases: A 10- to 15-year draw period, during which you can tap into your line of credit and are usually only required to make interest payments, and then a 10- to 20-year repayment period, during which you can no longer draw funds from your line of credit and must begin making payments on the money you borrowed.
Remember that nothing is stopping you from making payments during your draw period. In fact, it’s in your best interest to do so. The ability to make payments during the draw period will save you money by reducing the amount of interest you pay in the future when your repayment period arrives.
<h2>Cons of using a HELOC to consolidate debt</h2>
Unlike applying for a traditional credit card, the paperwork for taking out a HELOC is more involved. You’ll need to formally document your income and employment status. These lines of credit are subject to more stringent underwriting standards, similar to a loan or mortgage, and are meant to protect both the lender and borrower from issuing or receiving a loan.
When you offload your debts into your HELOC, the idea is that you’re starting with a fresh slate on your old credit cards. It can be tempting to reload your old lines of credit. It takes a certain level of discipline to balance these multiple credit lines and avoid landing yourself in an even worse position than where you originally started.
The bottom line with a HELOC is that you’re putting your home on the line. Failure to properly make payments could result in the lender foreclosing on your home, and nobody wants that.
By John DeGregorio
John DeGregorio is a finance writer based in Brooklyn, NY. He studied Journalism & Media at Rutgers University.
