The Pros and Cons of Using Home Equity to Pay Off Debt

3 Advantages of Using Home Equity to Pay Off Debt

Your home is one of the most significant assets you will own during your lifetime. For this reason, many savvy borrowers understand that leveraging this long-term investment can come with a ton of upside.

1- Get a Better Interest Rate
One of the best reasons to use your available equity to pay off debt is to save money in interest. Mortgage interest rates tend to have more favorable rates than other types of loans. Personal loans and credit cards often carry higher interest rates because they are unsecured, which increases the risk creditors incur.

Conversely, your home becomes collateral for standard mortgages and home equity loans that consolidate debt. If you ever end up defaulting on the debt, your lender has some recourse by foreclosing and selling your house to offset the loss.

2- Consolidate Payments
Another advantage of using your home's equity to pay off debt is to help consolidate your monthly payments. Doing this makes it easier to manage your monthly budget. You may even free up cash flow so that you can allocate more money to savings, retirement, and other purposes.

3- Lower Out-of-Pocket Costs
Unlike other debt consolidation loans, home equity loans and lines of credit often cost little or nothing to obtain. As a result, it should be easy to find lenders who require no upfront application fee and don’t charge expensive origination fees. You won't even need to bring cash to close in almost all cases.

2 Disadvantages to Using Home Equity to Pay Off Debt

While there are great reasons to consider your home's equity loan to pay off debt, it's also important to understand the potential downsides of leveraging your home. Whether you're using a home equity loan or a cash-out refinance, consider these factors before committing to any new credit.

1- Greater Risk of Foreclosure
If you overleverage your home’s equity in a loan to consolidate your debt, it can put you at a higher risk of foreclosure. If the market conditions change unexpectedly and home prices start to decline, you could end up owing more than what your home is worth.

A foreclosure also becomes more likely if you take out a new mortgage with a larger monthly payment. Should something unexpected impact your income, the increased monthly payment would quickly deplete your reserve assets.

2- Feeds Bad Spending Habits
Using your home equity loan to consolidate debt can have both short and long-term benefits, but it can put you in a weak financial position if you go out and rack up new debt. Ultimately, consolidating debt cannot correct bad spending habits. If anything, it can lull you into a false sense of security.

Our professional support team can help you feel confident about your decision of whether to tap your home equity loan to consolidate debt or not. Consolidating your debt is a great option as long as you can afford it. When Cake does a cash-out refi for customers, our clients manage to pay off their debt and get a significantly lower rate so their payment doesn't go up. Call us to discuss your options.