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How to Use Home Equity to Pay Off Debt
by
JG Wentworth
•
March 14, 2025
•
7 min
For many homeowners, their house isn’t just a place to live—it’s also their most valuable asset. After years of making mortgage payments and potential market appreciation, you may have built up significant equity in your home. This equity can be a powerful financial tool, especially when facing high-interest debt from credit cards, medical bills, or other loans.
Using home equity to consolidate and pay off debt can be an effective strategy for some homeowners, potentially saving thousands in interest payments and simplifying finances. However, this approach carries significant risks that must be thoroughly understood before proceeding…*
What is home equity?
Home equity is the difference between what your home is currently worth (its market value) and what you still owe on your mortgage. For example, if your home is valued at $350,000 and you have $200,000 remaining on your mortgage, you have $150,000 in equity.
Home equity builds in two primary ways:
- Mortgage payments: Each payment reduces your loan balance and increases your equity.
- Property appreciation: As your home’s market value increases, so does your equity.
How much equity can you access?
Most lenders won’t allow you to borrow 100% of your equity. Typically, you can access up to 80-85% of your home’s value minus your remaining mortgage balance. This limit helps protect both you and the lender by maintaining a cushion of equity.
Options for using home equity to pay off debt
Here are the most common ways you can leverage your home equity to pay off debt:
1. Home equity loan
A home equity loan (sometimes called a second mortgage) provides a lump sum of money that’s repaid over a fixed term at a fixed interest rate.
Key features:
- Fixed interest rate: Your rate remains the same throughout the loan term.
- Predictable payments: Fixed monthly payments for the life of the loan.
- Lump sum disbursement: You receive all funds at once.
- Terms: Typically 5-30 years.
- Closing costs: Similar to a primary mortgage, usually 2-5% of the loan amount.
Best for: Homeowners who need a large sum at once to pay off specific debts and prefer payment predictability.
2. Home equity line of credit (HELOC)
A HELOC functions more like a credit card, providing access to a revolving line of credit that you can draw from as needed during the “draw period” (typically 10 years).
Key features:
- Variable interest rate: Usually based on the prime rate plus a margin.
- Flexible borrowing: Borrow only what you need, when you need it.
- Interest-only payments option: During the draw period, you may have the option to make interest-only payments.
- Draw and repayment periods: After the draw period ends, you enter the repayment period (typically 10-20 years).
- Lower closing costs: Generally lower than home equity loans, sometimes only a few hundred dollars.
Best for: Homeowners who want flexibility and might need to borrow varying amounts over time.
3. Cash-out refinance
With a cash-out refinance, you replace your existing mortgage with a new, larger mortgage and take the difference in cash.
Key features:
- Single loan: Replaces your current mortgage entirely.
- Potentially lower interest rate: If rates have dropped since you obtained your original mortgage.
- Higher loan amount: Borrow more than your current mortgage balance.
- Full closing costs: Similar to getting a new mortgage (typically 2-5% of the loan amount).
- Reset loan term: Typically 15 or 30 years.
Best for: Homeowners who can obtain a lower interest rate than their current mortgage and need substantial funds.
4. Reverse mortgage (for homeowners 62+)
A reverse mortgage allows homeowners aged 62 and older to convert part of their home equity into cash without selling the home or making monthly mortgage payments.
Key features:
- No monthly payments required: The loan is repaid when you sell the home, move out, or pass away.
- Age restrictions: Must be at least 62 years old.
- Counseling requirement: Must complete HUD-approved counseling.
- Ongoing home costs: Must continue paying property taxes, insurance, and maintenance.
- Upfront costs: Can be high, including origination fees, mortgage insurance, and other closing costs.
Best for: Older homeowners who plan to stay in their homes long-term and need to supplement retirement income or pay off debts.
Compare Home Equity Options
Compare Home Equity Options
The benefits of using home equity to pay off debt
Some advantages to consider include:
1. Lower interest rates
The most compelling reason to use home equity to pay off debt is the interest rate advantage. Home equity products typically offer much lower rates than unsecured debt:
- Credit card average APR: 19-24%
- Personal loan average APR: 7-36%
- Home equity loan average APR: 7-9%
- HELOC average APR: 8-10%
This difference can translate into thousands of dollars saved in interest payments.
2. Tax deduction potential
Interest paid on home equity loans or HELOCs may be tax-deductible if the funds are used to “buy, build, or substantially improve” the home that secures the loan. The Tax Cuts and Jobs Act of 2017 eliminated the deduction for other uses (like debt consolidation), but it’s worth consulting a tax professional about your specific situation.
3. Simplified finances
Consolidating multiple high-interest debts into a single loan with one payment can simplify your financial life and make budgeting easier.
4. Improved credit score
Paying off credit card debt with home equity can lower your credit utilization ratio—a key factor in credit scoring. However, this only works if you avoid running up new credit card balances after consolidation.
The risks and downsides
Some potential drawbacks to keep in mind include:
1. Your home is at stake
The most significant risk is foreclosure. Unlike credit card debt or personal loans, home equity debt is secured by your home. If you can’t make the payments, you could lose your house.
2. Trading unsecured for secured debt
Credit card debt, while expensive, is unsecured. If you can’t pay, your credit score suffers, but your assets remain protected. Converting unsecured debt to debt secured by your home increases your risk.
3. Extended repayment period
While lower monthly payments may seem attractive, stretching debt repayment over 15-30 years means you could end up paying more in total interest, even at a lower rate.
4. Temptation to rebuild debt
Many homeowners who use equity to pay off credit cards end up accumulating new card balances, creating a debt cycle that leaves them worse off than before.
5. Closing costs and fees
The upfront costs of accessing home equity can be substantial—typically 2-5% of the loan amount for home equity loans and cash-out refinances.
6. Reduced equity buffer
Tapping into your home equity reduces your financial cushion. If housing prices decline, you could end up “underwater” (owing more than your home is worth).
Is using home equity right for your situation?
Leveraging your home equity is a major financial decision. Are you a good or poor candidate for this strategy?
Good candidates:
- Homeowners with substantial high-interest debt (especially credit cards).
- Those with stable, reliable income.
- Individuals committed to avoiding future debt accumulation.
- Homeowners planning to stay in their homes long-term.
- Those with significant equity (more than 20% after taking the loan).
Poor candidates:
- Those with unstable income or employment.
- Homeowners considering selling within a few years.
- People with a history of running up credit card balances repeatedly.
- Those with minimal equity in their homes.
- Individuals primarily motivated by lower monthly payments rather than overall interest savings.
Questions to ask before proceeding:
- Is my income secure enough to take on debt secured by my home?
- Have I addressed the spending issues that created my debt?
- Will I save enough in interest to justify the closing costs?
- Am I comfortable with the risk of putting my home on the line?
- Have I explored all other options for debt management?
The bottom line
Using home equity to pay off high-interest debt can be a powerful financial strategy when approached thoughtfully. The potential for significant interest savings and simplified finances must be weighed against the serious risk of putting your home on the line.
Success with this approach demands financial discipline, stable income, and a commitment to avoiding future debt accumulation. For many homeowners, the best strategy involves combining some use of home equity with fundamental changes to spending habits and financial management.
Before making any decisions, take time to thoroughly understand all options, consult with financial professionals, and create a comprehensive plan that addresses both immediate debt concerns and long-term financial health.
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