*This post was created in collaboration with Alpine Credits
If you’ve owned your home or property for several years, you’ve likely built some equity, especially if your home or property has increased in value over time. You can then leverage that equity to take out a loan and use the funds to cover a variety of big expenses, like home renovations or car repairs.
You can also use your equity to consolidate your debt, especially if you can secure a lower rate than what you’re currently paying. So, is using home equity to pay off debt a good idea?
Key Points
- If you have enough equity in your home, you may be able to access it to pay off your existing debt.
- Consolidating your debt using your home equity can help you save money in interest and streamline your bill payments.
- Depending on your lender, your finances, and the loan product, you may be able to borrow up to 80% of your home’s appraised value.
What Is Home Equity?
Home equity refers to the difference between the current value of your home and your outstanding mortgage balance. You can build equity in your home as you pay down your mortgage and as your home appreciates over time.
How To Calculate Your Home Equity
To calculate your home equity, simply subtract the remaining balance on your mortgage from the current value of your home:
| Value of Home – Remaining Balance of Mortgage = Home Equity |
For instance, if your home is worth $600,000 and you still owe $250,000 on your mortgage, then you would have $350,000 in home equity.
This is a simplified calculation. If you also owe money on other loans secured by your home, you’ll have to factor this debt into the calculation too.
How Much Can You Borrow Using Your Home Equity?
The amount you may borrow against your home’s equity depends on how much equity you have in your home and the type of loan you want:
- Home equity loan: Up to 80% of the appraised value of your home, less the mortgage balance.
- HELOC: Up to 65% to 80% of the appraised value of your home, less your outstanding balance.
That said, some lenders, usually alternative lenders, may go up to 90%.
Other factors can play a role in determining how large of a home equity loan you’ll be able to get, such as your income level, debt level, and credit health.
Common Documents Needed To Get A Home Equity Loan
When applying for a home equity loan, you’ll need to supply your lender with a variety of documents to prove your financial health. The exact documents required will depend on your situation and your lender, but can include any of the following:
- Government-issued photo ID
- Social Insurance Number (SIN)
- Letter of employment
- Bank statements
- Pay stubs
- T4 slips
- Notice of Assessment (NOA)
- Property’s deed
- Recent mortgage statements
- Recent property tax bill
How Does Debt Consolidation Work?
Consolidating your debt involves taking out one loan to pay off several loans. Typically, this is done to reduce the amount of interest paid on high-interest debts, like credit cards and unsecured personal loans. Debt consolidation can also simplify and streamline bill management.
Using your home equity is one way to consolidate and pay off your debts.
How To Pay Off Debt With Your Home Equity
Here are a few steps on how you can conquer your debt using your home equity and be financially stress-free.
Step 1: Calculate Your Total Debt
Typically, those who want to pay off their debts with their home equity have more than one type of debt. This can include debt from credit cards, payday loans, car loans, and personal loans, among others. Before applying for a home equity loan, calculate the total amount of debt you have first.
Step 2: Take Note Of Interest Rates You’re Paying
In addition to the total amount of debt you’re carrying, you should also take note of the interest rates you’re paying. If your home equity loan is not enough to pay off all your existing debt, you may want to focus on consolidating and paying off debts with the highest interest rate first.
Step 3: Figure Out How Much Equity You Have
Find out how much equity you have access to. You’ll need to know how much your home is currently worth and how much you have left on your mortgage balance to calculate your equity.
Your mortgage statement will tell you how much mortgage you have left to pay. But you’ll need to know how much your home is worth, which may be a little trickier to determine on your own. That said, you can get a rough idea of your home’s value by either;
- Checking your annual property tax bill for the assessed value
- Using an online source to find out what similar homes in your area are currently selling for
Step 4: Decide Which Option Is Best For You
As we discussed before, there are a few different ways to tap into your home equity, including a HELOC or home equity loan. Each of these will allow you to consolidate your debt. However, one will offer more benefits depending on your needs.
Home Equity Loan
A home equity loan works just like an installment loan, except it’s secured against the equity in your home. Like an installment loan, you’ll receive a lump sum of cash, which you have to pay back with interest over a set term. You can then use the funds to pay off your existing high-interest debt.
Home Equity Line Of Credit (HELOC)
A home equity line of credit (HELOC) is a type of revolving that works somewhat like a credit card. You’ll be approved for a set credit limit and can borrow from your account as often as needed. You only pay interest on the portion withdrawn and can draw from the account repeatedly — up to the credit limit — as the need arises.
Step 5: Pay Back Your Debts
Once you’ve been approved for your home equity loan you can use it to pay off your existing debt. This will make your debts easier to manage as you’ll be left with one payment. Moreover, home equity loans often have lower interest rates, which means you’ll save more money on interest by consolidating all your high-interest debts.
Advantages Of Using Home Equity To Pay Off Debt
There are plenty of reasons why you may want to consider using your home equity to pay off your debt:
- Lower Interest Rates. Interest rates are typically lower on loans secured by your home compared to many other types of loans, such as credit cards.
- Save Money On Interest. When you consolidate high-interest rates debts with a low-interest home equity loan, you’ll be paying less in interest.
- Flexible. Payment plans on home equity loans or HELOCs are usually flexible and can be customized to fit your needs.
- Easier To Manage Debt. You won’t need to keep track of all your different debt payments anymore. By consolidating all your debts, you’ll only have to worry about making a single payment.
Disadvantages Of Using Home Equity To Pay Off Debt
Along with the perks of using your home equity to pay down your debt come a handful of drawbacks to consider:
- Sizeable Equity Required. To be eligible for a home equity loan and have enough to cover all your high-interest debt, you’ll need plenty of equity. This may not be an option if you’ve just recently purchased your home and have not yet had a chance to build a lot of equity.
- Closing Costs. There are closing costs involved with a home equity loan that you will need to budget for.
- High Risk. When you take a home equity loan, you’re putting up your home as collateral. If you miss any loan payments, your home may be at risk of being seized.
- Mortgage Stress Test Required. You’ll need to pass the stress test to qualify for a home equity loan or HELOC if the loan is held by a bank or other federally-regulated lender.
Other Ways To Pay Off Or Consolidate Your Debt
In addition to tapping into your home equity to access funds to pay off your debt, there are other methods and products to consider, depending on the debt you carry.
Credit Card Balance Transfer
If you’re currently carrying a high credit card balance from month to month, you’re likely paying a lot in interest, given the high rates that come with credit cards. In this case, you may want to consider taking out a new card with an introductory transfer balance rate lower than the rate you’re currently paying.
For instance, some credit cards offer low or even 0% interest on balances for a certain amount of time, usually from 6 months to a year. By transferring your high-interest credit card balance to your new card, you can take advantage of this promotional period to pay down your debt without paying interest.
If you still carry a balance after this introductory period ends, you’ll begin paying a regular interest rate again, perhaps even higher than your original credit card.
Debt Consolidation Loan
A debt consolidation loan is a personal loan that you can use to pay off your debts. Ideally, this new loan will have a lower interest rate than what you’re paying on your existing debt. You can then use the funds from the debt consolidation loan to repay all your debts, leaving you with one loan payment at a lower interest rate.
The goal is to save money on interest, simplify your finances, and become debt-free sooner.
Bottom Line
If you have at least 20% equity in your home, you may qualify for a home equity loan with a lender like Alpine Credits. You can use that money to pay off your debts, especially high-interest debt. Homeowners can typically qualify for more money and often receive lower interest rates. If you have debt to consolidate or are interested in renovating your home, consider tapping into your home equity to help.
Home Equity Loan FAQs
What is a second mortgage?
What happens if I miss a payment?
How do you build home equity?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service
