Getting yourself out of debt can be a tricky business. Take debt settlement companies, for example. These organizations convince lenders to forgive part of your debt, but much of it still remains and continues to generate interest. Meanwhile, you have a reduced credit score, a fee due to the settlement company, and potential income tax on the forgiven debt. Did you know that if you’re a homeowner, you can use your home equity to pay off debt?
Using Home Equity to Pay Off Debt – Why It Works
Home equity debt relief solutions are different. Instead of paying a company for a service that may or may not work, you use what you already have.
What Is Home Equity?
Home equity is the portion of your home’s worth that is yours free and clear, with no obligation to the bank. If you have a mortgage, it equals the value of your home minus the amount that you still owe on your mortgage.
Calculating Your Equity
If you know the market value of your home and what you owe on your mortgage, you can calculate your home equity with pencil and paper. But finding the current market value of your home can be tricky.
Usually, the easiest way to calculate equity is to use this simple online tool. By entering your address, you can find exactly how much equity you have.
Uses of Equity
Life is expensive, and it’s fairly common for people to need access to their home equity. Some of the most popular reasons include:
- Paying medical bills
- Completing a remodeling project
- Minimizing student loan borrowing
Of course, repaying and refinancing debt also ranks among the leading reasons for tapping into home equity.
How to Use Home Equity to Pay Off Debt
Not all home equity programs are created equal. Some options make you pay quite a bit for the privilege of using your home equity loan to pay off debt. Others ask you to be in good financial standing before they will even consider liquidating your equity.
The riskiest options usually come in the form of loans.
Home Equity Lines of Credit
A Home Equity Line of Credit, more commonly known as a HELOC, is a kind of second mortgage that functions like a credit card. A lender approves you to borrow up to 85 percent of your home’s value minus the amount you owe on your mortgage.
You can borrow as much of this amount as you’d like and continue borrowing up to the maximum as you need it. Of course, this is assuming that you pay back the borrowed amount plus interest.
To apply for a HELOC, you will need:
- A debt-to-income ratio below 45 (or whatever benchmark your lender requires),
- A credit score of at least 620, and
- A home value that is 10 percent to 20 percent more than what you owe on your mortgage.
Different lenders have different requirements, but most if not all require you to be a reliable borrower and able to repay the amount they offer.
A Word of Caution
If you’re using a home equity loan to pay off credit card debt or other unsecured debts, a HELOC is unlikely to be your best option. If you can’t pay your credit card bills, you may not be able to pay off your HELOC, and then you risk losing your home. And even if you can pay off the loan, you end up paying interest and having no more equity than you started with.
Home Equity Loans
Unlike an available credit line that you can draw from as necessary, a home equity loan is a lump-sum payment that you repay over time. It usually involves fixed interest rates and consistent monthly payments.
Like a HELOC, a home equity loan usually gives you up to 85 percent of your equity. Your actual borrowable amount may vary based on your credit score, your household income, and the current value of your property.
When Not to Borrow
Home equity loans can be great if you need money in the near future but expect to be back in good financial shape after that. If you expect your needs to be ongoing, taking on additional debt – and interest, which will actually increase your debt – may not be a good idea. If you’re interested in learning more about this process, check out our blog on using HELOC to pay off mortgage.
Sell and Move
Any home equity loan will require interest payments, which translates to a financial loss. It may be in your best interest to sell your home and get the equity without strings. But even then, you may not end up ahead.
If you bought a home for $250,000 and paid off $100,000, you get $150,000 in your pocket when you sell. But if you bought your home at $300,000, you still have a loss of $50,000, despite the fact that you now have cash on hand.
You also need to consider that although you receive $150,000 from the sale, you’ll have to pay your real estate agent, your movers, and whoever is selling or renting your next home to you. To say nothing of the emotional fallout involved in leaving your home.
In the past, you had to choose between leaving your home behind and taking on the financial burden of a loan. Neither of these options is ideal.
Enter a sale-leaseback. This unique program allows you to sell your home and remain in place as a tenant. You can stay there until you decide to repurchase your home or relocate, whichever works better for you.
A sale-leaseback puts the homeowner back in control, both financially and personally. Working through this solution, you:
- Enjoy clear communication about rates and prices
- Close in less time than traditional home sale
- Stay until you’re ready to re-purchase or move
- Get the cash you need to work toward your goals
With a sale-leaseback program, the only ongoing financial obligation you take on is the monthly rent you will pay, which can be calculated based on the market rate for your geographic area.
You convert the equity you’ve built up into cash without uprooting your household.
When it comes to paying down debt, it can feel like an endless process. If you’re looking for a faster and more effective way to pay down debts, it may be a good idea to turn to your home equity. Consult with a financial advisor to figure out if a sale-leaseback might be a viable solution to your situation.