How to Use Home Equity to Pay Off Debt

Debt can be overwhelming, especially when it accumulates at high interest rates. For homeowners, tapping into home equity is a powerful way to consolidate and pay off debt while securing lower interest rates. Whether you are dealing with credit card debt, unsecured personal loans, or high-interest auto loans, using your home’s equity can provide a structured repayment plan with lower interest costs.

Here’s how you can use your home equity to pay off debt, with real-life examples of homeowners who successfully leveraged their home’s value to regain financial stability.

How to Pull Equity from Your Home​

Your home’s equity is the difference between what your property is worth and how much you still owe on your mortgage.

If your home is worth $400,000 and your remaining mortgage balance is $200,000, you have $200,000 in home equity.

Banks and mortgage lenders typically allow homeowners to borrow up to 80%–85% of their home’s value, depending on their financial profile and the loan type.

Four Ways to Use Home Equity to Pay Off Debt:

1. Home Equity Loan – A lump sum loan with a fixed interest rate.
2. Cash-Out Refinance Mortgage– A new mortgage that replaces the old one while cashing out equity.
3. 2nd Mortgage Loan – A new loan in addition to the existing mortgage.
4. HELOC – A revolving credit line you can borrow from as needed.

Each of these options serves different needs, which we will explore with three case studies demonstrating how real homeowners used these methods effectively.

1. Home Equity Loan – Fixed Sum for Debt Consolidation

A home equity loan provides a lump sum amount that you repay in fixed monthly installments over a set term (typically 5–20 years). Since it’s secured by your home, interest rates are much lower than credit cards and personal loans. Savvy homeowners have been choosing a home equity loan for debt consolidation for nearly 4 decades.

Pros:

✔ Fixed monthly payments provide stability.
✔ Lower interest rates compared to credit cards and personal loans.
✔ Can be used to consolidate multiple debts into one payment.

Cons:

✖ Higher monthly payments than a HELOC, as repayment starts immediately.
✖ If home values drop, you could owe more than your home is worth.

Case Study: Retired Couple Pays Off Credit Card and Hard Money Loan

Situation: Robert and Susan, a retired couple, had accumulated $35,000 in credit card debt and $25,000 in a high-interest hard money loan they took out years ago to start a small business. Their monthly debt payments were eating into their fixed retirement income.

Solution: They applied for a $60,000 home equity loan with a fixed 6.5% interest rate and a 15-year repayment term.

Outcome: With their high-interest debts eliminated, they now had a single lower monthly payment. This freed up significant cash flow for their retirement, allowing them to enjoy their golden years with less financial stress.

2. Cash-Out Refinance – Lower Mortgage Rate + Debt Payoff

A cash-out refinance allows you to refinance your existing mortgage into a new, larger loan and receive the difference in cash. This is an excellent option for borrowers who can secure a lower mortgage rate while also pulling out funds to pay off debt.

Pros:

✔ Lower interest rates compared to unsecured debt.
✔ Converts high-interest debt into a lower-cost mortgage payment.
✔ One consolidated monthly payment instead of multiple debt payments.

Cons:

✖ Increases your total mortgage debt.
✖ Comes with closing costs (similar to a new mortgage).
✖ Extends the time needed to pay off your home.

Case Study: Self-Employed Woman Uses Cash-Out Refinance for Debt Payoff

Situation: Sarah, a self-employed business owner, had $40,000 in high-interest credit card debt and a 6.5% mortgage rate. Because of inconsistent income documentation, she couldn’t qualify for traditional personal loans with favorable terms.

Solution: She refinanced her mortgage into a 30-year fixed loan at 5.25%, cashing out $40,000 to eliminate her credit card balances.

Outcome: Sarah reduced her overall interest payments and combined her credit card debt into her mortgage at a much lower rate. With a more manageable monthly mortgage payment, she improved her financial stability and had additional cash flow to reinvest in her business.

3. Second Mortgage – A Separate Loan for Debt Consolidation

A second mortgage is a new loan taken in addition to your existing mortgage. Unlike a cash-out refinance, it allows you to keep your original mortgage terms intact while accessing extra funds.

Pros:

✔ You don’t have to refinance your first mortgage.
✔ Good for homeowners who already have a low mortgage rate.
✔ Fixed interest rates make budgeting predictable.

Cons:

✖ You now have two mortgage payments.
✖ Higher interest rates than first mortgages.
✖ Increases the risk of foreclosure if payments are missed.

Case Study: Couple Uses Second Mortgage for Debt Consolidation

Situation: Mark and Lisa, a married couple, were struggling with $50,000 in personal loans and credit card debt with interest rates above 20%. Their combined monthly payments were difficult to manage, and they were barely making a dent in their balances.

Solution: They took out a second mortgage for $50,000 at 7% fixed interest. This allowed them to pay off their high-interest debts while keeping their first mortgage at its existing low rate.

Outcome: After securing a 2nd mortgage to consolidate debt, their total monthly payments decreased, making it easier to manage their finances. By consolidating, they were now paying significantly less interest and could focus on saving for the future instead of juggling multiple debts.

4. HELOC – A Flexible Option for Managing Debt

A Home Equity Line of Credit is a revolving credit line, similar to a credit card, that lets you borrow money as needed. The HELOC is best suited for borrowers who want flexibility and do not need a lump sum all at once.

Pros:

✔ Lower interest rates than personal loans and credit cards.
✔ Flexibility to borrow only what you need.
✔ Interest-only payments during the draw period.

Cons:

✖ Variable interest rates can lead to higher payments over time.
✖ Temptation to overborrow.
✖ If home values drop, you may owe more than your home is worth.

Best For:

• Homeowners who need flexible access to funds.
• Borrowers who want to pay off debts gradually over time.

Final Thoughts: Choosing the Right Home Equity Option for You

Using home equity to pay off debt can be a smart financial move if done correctly. However, it’s important to choose the right method based on your specific needs and financial situation:

✔ Choose a Home Equity Loan if you prefer fixed payments and all of the money dispersed at once.
✔ Choose a Cash-Out Refinance if you can secure a lower mortgage rate while consolidating debt.
✔ Go for a Second Mortgage if you want to keep your first mortgage unchanged but need cash.
✔ Use a HELOC if you want a flexible borrowing option to pay off debt over time.

Before tapping into your home equity, compare interest rates, fees, and loan terms. Consider consulting a financial advisor or mortgage specialist to determine the best option for your debt consolidation goals.

When used wisely, home equity can be a powerful tool to eliminate debt and achieve long-term financial stability.