January 14, 2022
Should You Use a HELOC to Pay Off Debt?
Many homeowners find themselves in debt and wonder if they should use a HELOC to pay off debt. That can be an excellent way to pay less interest if you have a solid plan to pay the debt off quickly. Let’s explore the pros and cons of using a HELOC to get out of debt.
I’m in debt — what debt should I pay first?
Many borrowers wonder how to get out of debt. And there are a variety of answers to that question. Some financial advisors say to pay off the highest interest right off the bat. Dave Ramsey takes the snowball approach of paying off the smallest credit card first regardless of the interest rate. That way, you’ll see fast progress and will feel motivated.
Ultimately, it comes down to whatever plan works for you. A plan has to be doable, reduce your debt load, and be easy to follow. One advantage of paying the highest interest loan first is that you’re paying less interest. And you can take those savings once that debt is paid off and apply them to the next debt you want to tackle.
Transferring High-Interest Debt
There’s also the strategy of transferring high-interest debt to 0% offers. That can work if you’re able to pay that 0% off before the rate goes sky-high. But, without a plan, it’s easy to fall into the debt cycle where you don’t make any progress, and you’re just moving debt around.
One of the first things to do is to examine how you got into debt. Suppose it was because of a one-time setback like an illness or job loss. That’s one thing. But, if you don’t have a budget and have a habit of over-spending, transferring debt is not the answer. You need to change your spending habits, examine your income, and stick to a budget.
HELOC Interest vs. Credit Card Interest
If you pay off your high-interest credit cards and personal loans with a HELOC, your minimum payment will probably be much lower. That’s because many HELOCs have an interest-only payment in the first part of the loan. Here’s a hypothetical example:
$50,000 of credit card debt with an average interest of 13% could cost you $1,000 a month as a minimum payment. Compare that to a HELOC payment at 3.75% for an interest-only payment of $160. But keep in mind, that’s an interest-only payment, and you will not be paying down the principal.
Using a HELOC to Pay Student Loans
If you have student loans with high interest and large payments, paying them off with a HELOC may be the answer. Just like with credit card debt, though, you have to have a specific goal of when you want the debt paid off. Lowering your payment may not be the answer if you spread the loan out and end up paying more interest.
Another option to explore is consolidating your student loans with a student loan refinance loan. The advantage of this over a HELOC is that it’s not secured by real estate. Just like with any loan, compare the interest rate, term, payment, and how much interest you’ll pay over the life of the loan.
Pay More Than the Minimum Amount
There are a few big things to keep in mind. First of all, the minimum payment will most likely be interest only. Also, the term for the HELOC is longer, so you may end up paying more interest over time which is not a smart financial move if your goal is to save money on interest and get out of debt.
The way to take advantage of a low-interest HELOC is to pay more than the minimum amount. For example, if you were paying $1,000 on credit cards — pay that same amount on the HELOC even though the interest-only payment might only be $160. That way, you’ll pay the loan off faster. With discipline, you can make more progress and pay less interest.
How to Pay off HELOC Faster
The great thing about a HELOC is that you don’t have to only pay the minimum interest-only payment. But you can if necessary. If your goal is to become debt-free, you can’t do that by paying the interest only. If you’re currently paying $1,000 on credit card debt — pay that same amount on your HELOC and watch how fast the balance will come down.
Plus, since it’s a line of credit — you can pay it off now and use it again later. Here’s an example: you have $30,000 in high-interest credit card debt. You pay it off in two years. Now you’d like to sell your home, but it’s dated and needs home improvements. So, you take out $50,000 to upgrade your kitchen and bathrooms. Your house sells quickly for your asking price, and you pay off your HELOC with the proceeds.
The Smart HELOC Consumer
If you want to use a HELOC to your advantage for getting out of debt, it’s only one side of the solution. In addition to transferring your debt over, you also need to cut your spending and most likely make more money. Look to see what got you into debt and attack the sources.
The most important thing is to not go into further debt. By cutting the amount of interest you’re paying, you'll get there if you pay more than the minimum. It’s vital to plan on when you want the HELOC paid off. For example, if you borrow $40,000 and want it paid off in 4 years, you’ll need to pay $10,000 a year, plus interest.
A HELOC can be a great deal, especially when you have discipline and use this type of home equity loan to your advantage.
To learn more about PenFed loans or what loan is right for you: