Why Tapping Into Home Equity to Pay Off Debt Is Almost Always a Bad Idea

If you have a lot of credit card debt or other consumer debt, you may want to consider debt consolidation. This process involves getting a new loan and using it to pay off other debts. If your new loan has a reduced rate, you can lower payoff costs and make the process of becoming debt-free easier.

If you're a homeowner, a home equity loan may seem like an attractive option for a debt consolidation loan. Home equity loans tend to have lower rates than personal loans, which can make them seem like an especially good option for reducing the cost of debt payoff. But the reality is, there is one really big reason why tapping into home equity to repay debt is almost always something to avoid.

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The huge downside of using a home equity loan for debt payoff

Although borrowing against your home may seem like it's a good idea due to the low rate, the sad reality is when you take this approach, you are putting your house in jeopardy.

In most situations, when you're using a home equity loan to pay off other debts, those debts are unsecured. This means there isn't any collateral that guarantees a lender will be paid. If lenders want to try to collect, they could go to court and get a judgment against you that could potentially lead to liens on your property or wage garnishment.

But, often, they won't bother. They'll usually charge off the debt and sell it to a collector, who will use a variety of tactics to try to recover the money but who, again, can't easily come after your assets without court action.

When you have unsecured debt, not paying it can definitely have consequences -- but those consequences very rarely, if ever, involve losing your house. If you have a home equity loan, on the other hand, then if you don't pay the loan, it's very likely the lender will foreclose on you as long as it thinks it can generate enough from the sale to recoup its unpaid funds and costs.

This means if you have tapped into home equity to repay unsecured debts, you have directly put your house at risk when it wasn't before. If something unforeseen happens and you end up not being able to make the payments, there's a very real chance your home will be lost versus almost no chance of that happening if you couldn't pay your unsecured debt.

What should you do instead?

Instead of tapping into home equity, consider these other options for debt refinancing.

• A balance transfer: This is an ideal choice if you have credit card debt to consolidate and refinance. You can get a balance transfer card with a 0% interest rate for a period of time, and then transfer your existing debt balance to it, effectively reducing your interest rate to 0% (although you will usually pay a balance transfer fee of about 3% to 4% of the transferred amount).
• A personal loan: Personal loans are unsecured debts that can be used for debt consolidation and refinancing. Well-qualified borrowers can typically get a loan at a lower rate than their credit card issuer would charge them, and the loan will also have fixed monthly payments and a set payoff time, which cards don't.

Both of these options can help you deal with debt by refinancing and/or consolidating. But unlike with a home equity loan, you won't be gambling your home on the hope you'll be able to pay off the loan.