For homeowners wanting to benefit from all the equity they’ve built up in their homes, using it to pay off debt can seem like a perfect solution. Still, it’s important to know what is involved in using your home equity to pay off debt.
What is home equity?
Home equity refers to the difference between what you owe on your mortgage and the value of your home. For example, if your home is worth $450,000 and you have $200,000 left to pay on your mortgage, then you have $250,000 in home equity.
Whenever you pay down your mortgage, the equity increases. If the value of your home rises, your equity will also increase.
Ways to Access Your Home Equity
One of the benefits of having equity in your home is the ability to use it to help better your financial situation, such as paying down your debts. There are different mortgage solutions you can use to convert your equity into cash, including:
A Home Equity Line of Credit, or HELOC, works like a credit card. Lenders will offer you a line of credit to use and you can spend as much as needed, leaving the rest for the future. During the draw period, you’ll only have to pay interest payments on the amount you’ve withdrawn.
Interest rates on HELOCs are variable, which means they’ll go up and down according to the market. When the period is over, you’ll need to start making larger payments to pay it off. Expect to pay some administrative costs for your application, including the appraisal fee, title search, title insurance, and legal fees.
Home Equity Loan
With a home equity loan, you’ll receive a lump sum from a lender. However, unlike the HELOC, you’ll need to start making payments on the loan right away. These loans have fixed interest rates, so your monthly payments will not fluctuate.
The cash-out refinance method is basically taking out another mortgage on your home. You use the money to pay off your current mortgage. Then, you’ll be able to use the remaining cash to pay off your debts. There are some additional considerations before going down this path, including:
- The interest rate on your new mortgage may be different.
- Your mortgage insurance premiums will also change.
- You’ll need to pay additional fees like the appraisal fee, title search, title insurance, and legal fees.
Benefits of Using Equity to Pay Down Debt
There are many good reasons to cash in your equity and pay down your debt, including:
- Consolidate debt at a lower interest rate
- Completely pay off a debt
- Combine debts into a single monthly payment
- Save money over time