How to Use a HELOC to Consolidate Your Debt

Home values have been rising at unprecedented rates the past couple of years.  In fact, according to recent data, the average homeowner is now sitting on about $186,000 in available home equity — the highest average ever on record. Most homeowners leave this equity alone until it’s time to sell their home, but that value can represent a significant financial asset and make up a notable portion of their overall net worth.

Unfortunately, consumer debt is also rising at record rates. Studies show that the average American now carries about $90,460 in total debt between credit card balances, personal loans, auto loans, and more. Much of this is high-interest debt, which can be very costly and has the potential to derail the savings efforts of many individuals.

If you are someone who falls into both categories — you’re a homeowner with equity in your property and also a consumer with existing debt — a HELOC can be a great way to access your home’s equity and consolidate those balances. Here’s how it works and why you might want to consider going this route. 

What a HELOC Does

A home equity line of credit, also known as a HELOC, is an open-ended line of credit backed by the equity (or owned value) of your home. This line of credit is offered by banks, credit unions, and online lenders, allowing you to access a portion of your home’s equity for a variety of uses.

HELOCs act a bit like revolving credit card accounts. Even though you’re offered an account and given a credit limit, you aren’t actually obligated to use that money unless you want (or need) to. If you do decide to borrow money, you’ll make monthly payments based on the amount withdrawn and your interest rate. If you never touch the credit limit, you won’t pay anything extra, except for an annual maintenance fee, and will simply have a financial safety net at the ready.

The money from a HELOC can be used to do just about anything, including:

• Paying off debt

• Renovating your home

• Making large purchases

• Taking a family vacation

• Investing in other property

HELOCs usually involve a draw period, or a set timeframe during which you can pull from the line of credit at your discretion. This draw period often lasts about 10 years; after that, you’ll go into repayment-only mode. The repayment period typically lasts between 10 and 20 years and you will need to make principal and interest monthly payments until the borrowed amount is repaid. You can also apply for a new HELOC through your preferred lender at that time.

Using a HELOC to Consolidate Your Debt

Consumer debt can be both costly and confusing to manage, especially if you have more than one type of debt or account balance. A HELOC, however, can be a great way to pay off multiple balances, save money, and simplify the entire process.

Some reasons to consider consolidating your debt:

• It’s easier to manage. If you have three credit cards, one auto loan, and one personal loan, you are juggling five different account balances, minimum payments, and due dates each month. Using a HELOC to pay off and consolidate all of that debt would streamline your finances, leaving you with just one monthly payment and due date to track.

• You can save money. Credit card interest rates have climbed steadily, and it’s not uncommon for consumers to see rates of 25%, 35%, or more. By consolidating into a secured HELOC, you can pay off your debt at a significantly lower rate.

• You may get out of debt faster. With less interest to pay, your money can go further each month, helping you get out of debt sooner and for less.

Also, since a HELOC uses your home’s equity as collateral, it can sometimes be easier to get approved for larger amounts (and lower rates) than you’d find with, say, a personal loan. This might allow you to consolidate all of your debt, including your car or even student loan balances.

How much can you borrow with a HELOC?

The equity in your home is the difference between its market value and any outstanding balance of all liens on the property - usually your current mortgage loan balance. So, if your home is worth $350,000 and you only owe the bank $210,000, you have $140,000 in available equity to borrow against.

HELOCs use that equity as collateral to secure (or back) your line of credit, though you won’t be able to access all of it. Instead, you’ll be allowed to borrow up to a certain percentage of your home’s total value, called an LTV (loan-to-value ratio). 

Each lender sets its own LTV. Let’s say your lender allows for an LTV of up to 85%. Using the home values above, you’d be able to borrow as much as $87,500 with a HELOC. 

85% of $350,000 home value = $297,500

$297,500 - $210,000 remaining mortgage balance = $87,500 HELOC maximum

This leaves about 15% of your home’s value safely in the property, to protect both you and your lender.

Should I consolidate my debt with a HELOC?

HELOCs often come with variable interest rates, so it’s important to note that these may change over time. You should also consider the disadvantages of tapping into your home’s equity, especially if you plan to sell the property anytime soon.

With that said, HELOCs can be very beneficial products for consumers with other forms of debt. Rather than leaving your home’s equity untouched, you can use that asset to pay off other balances, such as credit card debt or personal loans. By consolidating these other accounts with a HELOC, you can not only simplify your debt but also save yourself money along the way.