Should You Use Your Home Equity To Pay Off Your Debt?

Should You Use Your Home Equity To Pay Off Your Debt?

Written by Caitlin Wood
Last Updated September 14, 2022

If you’ve owned your home or property for several years, it’s very likely that you’ve built some equity, especially if your home or property has increased in value over the years. When you have equity in your property you can leverage that equity to take out a loan. 

You can use your equity to take out several types of loans such as a home equity loan or a home equity line of credit. These can be particularly helpful in managing and consolidating your debts as you can borrow large sums with low-interest rates.

Find out how you can use your home equity to stay on top of your financial responsibilities as a homeowner. 

What Is Home Equity?

When you take out a mortgage to purchase a home, you don’t own the home until you pay it off.  However, as you make your mortgage payments (or as your property value increases), you’ll build equity in your home. Home equity refers to how much your home is worth versus how much you have left to pay off. 

How To Calculate Your Home Equity?

To calculate your home equity, let’s assume you have a property worth $600,000 and you currently still owe $250,000. That would mean you have $350,000 in home equity. The following formula can be used to quickly calculate your home equity:

Value of Home – Remaining Balance of Mortgage = Home Equity

How Much Can You Borrow Using Your Home Equity?

In general, lenders will allow borrowers to borrow up to 80% of their home’s equity. However, some lenders, usually alternative lenders, may go up to 90%. 

There are other factors that can play a role in determining how large of a home equity loan you’ll be able to get. This may include your income level, debt level and credit health.

Alpine Credits

Common Documents Needed To Get A Home Equity Loan

  • Name, date of birth, contact information, address (government-issued photo ID)
  • Social Insurance Number (SIN)
  • Proof of employment (income, employers name, job title)
  • Bank account details (for direct deposit and withdrawal of payments)
  • 3 months’ worth of bank statements
  • Property’s deed
  • Recent mortgage statements
  • Most recent property tax bill

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 such as credit card debt, payday loan debt, car loan debt, and personal loan debt.  As such, before applying for a home equity loan, your first step should be to calculate the total amount of debt you have. 

You should also take note of the interest rates you’re paying. In, general, you’ll want to use your equity to pay off debts that have a higher interest rate than your home equity loan.

Step 2: Figure Out How Much Equity You Have

Once you’ve figured out how much debt you want to cover, you should calculate how much equity you can tap into. You can check your mortgage statement to find out how much mortgage you have left to pay and see how much your home was appraised for. Using these numbers and the formula above, you can calculate the equity you have in your home.

This will allow you to estimate the maximum amount you can borrow through your home equity and if it’s enough to cover your debts. Keep in mind that once you go to your lender and apply for a home equity loan, they will likely want to reappraise your home to determine its value.

Step 3: 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 home equity line of credit, home equity loan or a second mortgage.  All of these will allow you to consolidate your debt, however, one will offer more benefits depending on your needs.

Home Equity Line Of Credit

 A home equity line of credit can provide you with more flexibility than the other two options. With a HELOC, you only have to pay interest on the amount you use and you can continually access your equity as you repay it. Moreover, you don’t have to pay the principal (only interest) until the draw period is over, making payments more affordable.  However, do note that HELOCs typically come with variable interest rates, which means payments fluctuate based on the prime rate. 

Home Equity Loan

A home equity loan works just like an installment loan, except it’s secured against the equity in your home. With this option, your payments are fixed making it easier to budget. Like an installment loan, you’ll receive a lump sum of cash which you have to pay back with interest over a predetermined period (5 to 30 years).

Step 4: Pay Back Your Debts

Once you’ve been approved for your home equity loan you can use it to pay off all your debts. This will make your debts easier to manage as you’ll only have to look after 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. 

Just be sure not to accumulate more debt because a home equity loan is secured against your home, so if you miss any payments, your home could be seized as a result. 

Advantages Of Using Home Equity To Pay Off Debt

  1. Lower Interest Rates – Interest rates are typically lower than most other types of loans due to the security.
  2. 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. 
  3. Flexible – Payment plans are usually flexible and can be customized to fit your needs
  4. 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

  1. You Need Equity –  In order to be eligible for a home equity loan, your home must have some equity to put up in order to get approved.
  2. Fees – In the case of a second mortgage there are usually a number of fees that need to be covered.
  3. High Risk – When you take a home equity loan, you’re putting up your home as collateral. As such, if you miss any payments, your home can be used as collateral to recoup payment.  
  4. Hard To Qualify – Banks can sometimes be tricky to deal with, especially when it concerns taking on a second mortgage. You should consider working with an alternative lender if you’re having difficulty with your bank

Home Equity Loan FAQs

What is a second mortgage? 

A second mortgage is a loan you take that is secured against your home equity. Second mortgages can be broken down into two types of loans: home equity loans and home equity lines of credit. 

What happens if I miss a payment? 

If you miss a home equity loan payment, your house can be seized to recoup the payment. Since home equity loans are considered second mortgages, your home would be sold and used to first pay off your mortgage and then your home equity loan (second mortgage). 

How do you build home equity?

Home equity can be built in two ways: by paying your mortgage payments and by increasing your home value through renovations. Your home equity can also increase by changes in the market. 

Bottom Line

If you have paid at least 20% of your mortgage balance, you can qualify for a home equity loan with a lender like Alpine Credits. 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.

Rating of 5/5 based on 4 votes.

Caitlin Wood is the Editor-in-Chief at Loans Canada and specializes in personal finance. She is a graduate of Dawson College and Concordia University and has been working in the personal finance industry for over eight years. Caitlin has covered various subjects such as debt, credit, and loans. Her work has been published on Zoocasa, GoDaddy, and deBanked. She believes that education and knowledge are the two most important factors in the creation of healthy financial habits. She also believes that openly discussing money and credit, and the responsibilities that come with them can lead to better decisions and a greater sense of financial security.

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