Managing debt can be difficult, especially when dealing with high-interest credit cards, personal loans, and other outstanding obligations.
In situations like this, many people in debt might consider taking out a debt consolidation loan.
Homeowners, however, have additional options available—using their home’s equity to consolidate debt.
But which is better: a home equity loan or a debt consolidation loan?
In this article, we’ll explore the differences between these two options, their benefits and drawbacks, and how to determine which is right for your financial situation.
What is a home equity loan?
A home equity loan is a way to borrow money using your home’s value as collateral. Your equity value is the difference between your home’s worth and your mortgage balance.
You can typically borrow up to around 80% of your home’s equity. These loans offer lower interest rates and provide a single lump sum of cash you repay over a fixed period with a fixed interest rate.
By choosing this path, you pay off all your existing debt with the lump sum from your home equity loan, much like a debt consolidation loan.
What is a debt consolidation loan?
A debt consolidation loan is designed to combine all your debts into one—it has no other purpose.
You don’t need to use your home or any other asset as a guarantee. Because there is no collateral involved, the interest rates are usually higher.
Here, too, the lender gives you a single lump sum to pay off all your current debts, and then you pay back the new loan in regular monthly installments.
In both cases, it simplifies your payments by consolidating them into one.
Comparing home equity loans and debt consolidation loans
So, if they serve the same purpose, which product is better for consolidating debt?
Interest rates
The interest rate significantly differs between home equity loans and debt consolidation loans.
Generally speaking, home equity loans have lower interest rates because they are backed by your home as collateral, resulting in potential interest savings.
In contrast, unsecured debt consolidation loans typically have higher interest rates, although they may offer better rates than high-interest credit cards.
This makes them a popular choice for consolidating debt without using your home as collateral, especially for many younger adults who may not yet own a home.
Risk and collateral
The primary risk of a home equity loan is that your home serves as collateral. If you’re unable to make the loan payments, you could face foreclosure.
This makes home equity loans a potentially risky option if your income is unstable or you’re concerned about your ability to keep up with the payments.
On the other hand, a debt consolidation loan doesn’t require collateral, so your home isn’t at risk if you default.
However, lenders often mitigate their risk by charging higher interest rates because the loan is unsecured.
Additionally, qualifying for a debt consolidation loan may require a higher credit score, as lenders closely evaluate your creditworthiness without collateral.
Loan amounts and access to funds
With home equity loans, you can borrow larger amounts based on your home’s equity.
This is a good option if you have significant debt to consolidate or use some of the loans for other major expenses, such as home improvements or education costs.
Debt consolidation loans typically offer smaller loan amounts than home equity loans based on your credit score, income, and other financial factors.
However, they can still be effective for consolidating smaller debts, especially if you want to avoid using your home as collateral.
Loan terms and monthly payments
When you borrow money using your home’s value or to pay off multiple debts with either a home equity or a debt consolidation loan, you usually get a fixed interest rate. You must pay back the money over time.
However, the advantage of home equity loans is they often give you more time to pay back (anywhere from 5 to 30 years), so your monthly payments are lower—but you might end up paying more in interest overall.
On the other hand, debt consolidation loans usually last for a shorter time (2 to 7 years), so you have higher monthly payments, but you’ll be debt-free sooner and could save money on interest in the long run.
Tax benefits
One potential advantage of a home equity loan is the possibility of tax-deductible interest.
If you use the funds for home improvements or certain other qualifying expenses, the interest you pay on a home equity loan may be tax-deductible.
However, tax laws are complex and can change, so it’s important to consult a tax advisor to understand how this might apply to your situation.
Debt consolidation loans do not offer tax benefits, as the interest is not tax-deductible.
Choosing between a home equity loan and a debt consolidation loan
When choosing between a home equity loan and a debt consolidation loan, start by assessing your financial situation, including:
- Your debt amount
- Credit score
- Willingness to use your home as collateral
A home equity loan may offer lower interest rates if you have significant equity and can comfortably make payments.
However, a debt consolidation loan could be safer despite potentially higher interest rates if you’re concerned about risking your home or have a lower credit score.
Additionally, consider your long-term financial goals and plans for your home when deciding which loan best suits your needs.
Does neither option work for you? Consider a HELOC
A Home Equity Line of Credit, or HELOC, is another way to access your home equity.
Like a home equity loan, you’ll leverage your home’s collateral to borrow from. The difference is that a HELOC works more similarly to a credit card.
Where a home equity loan offers a lump sum payment, a HELOC allows borrowers to draw as much from their equity line during the draw period as they’d like. This way, you only borrow and pay back exactly what you need to pay off your debts.
There’s also a set repayment period that usually lasts 10-20 years, giving borrowers plenty of time to devise a repayment plan.
HELOCs often provide more flexibility to borrowers looking to pay off and consolidate their debts.
If this sounds like a better option for your situation, check out HomeEQ’s simple and quick digital application and tap into your home’s equity for debt consolidation today.
Home equity loans vs debt consolidation: wrap-up
When deciding between a home equity loan and a debt consolidation loan, consider the pros and cons of each loan type.
Home equity loans can be attractive because of bigger loan amounts and lower interest rates, but they can put your home at risk.
On the other hand, debt consolidation loans have higher interest rates but do not risk your home and may be easier to obtain with a strong credit history.
A HELOC can be a flexible alternative to both of these options. It allows you to borrow only what you need and pay it back during a wide repayment window.
The best choice depends on your financial needs, risk tolerance, and long-term goals.
Start your easy digital home equity application with HomeEQ today.