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Ask Dr. Don

Should I get a home equity loan?

Dear Dr. Don,
First, I don't know much about finances. I have a question. I share a home with my mother. We have a small $9,000 loan on our home. I would like to build a garage, and consolidate about $8,000 in credit card debt. Also, my lease is up on my vehicle, and I need another one. Would a home equity loan be the right way to go? Our home is worth around $95,000. With a home equity loan, won't my payments be much less than paying each bill or loan separately? Thank you for any help you can give me.
Steven Solidify

Dear Steven,
Using a home equity loan has two advantages over other types of non-mortgage consumer debt. First, since the loan is secured by the equity in your home, the interest rate is typically lower than the interest rate on unsecured debt. Second, if you can use the mortgage interest deduction on your income taxes, the effective interest rate is even lower.

One disadvantage of using home equity loans to consolidate debt is that you spread the debt out over a much longer period, typically 10 to 15 years. Taking 10 years to pay off a car or credit card debt will actually increase the total interest paid, even though the interest rate is lower because of the longer loan term.

Another disadvantage is that many people don't have the discipline to stop using their credit cards, and before they know it their credit card balances are right back to where they were before the debt consolidation. All they gained from debt consolidation is the ability to buy more stuff on credit.

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I used Bankrate's mortgage calculator along with some guesstimates on how much you would pay for a new car, a new garage, and how many years you have remaining on the mortgage to come up with the table below.

The table shows how extending the loan term reduces the monthly payment. It also shows you how adding additional principal payments to the monthly payment can shave six years off the 15-year mortgage and dramatically reduce your total interest expense. Even though the table won't match your situation exactly, it provides a framework for you to use in constructing a table to calculate your numbers.

How extending a loan term reduces your monthly payment
Credit card
Combined loans
Cash-out refinancing
Cash-out refi
+ add'l principal pmts.
Loan Term(yrs.)
Loan Amount
Interest Rate*
Total Interest
*Using Bankrate averages


A cash-out refinancing allows you to consolidate your current mortgage along with the other debts, and I think it is a better approach in your situation vs. using a home equity loan or home equity line of credit (HELOC).

It depends on the interest rate on your existing mortgage, the interest rates available on the new mortgage and home equity loan, and the difference in closing costs between the two approaches. Closing costs will probably be higher with the cash-out refinancing, and that is a consideration in deciding between the two approaches. You can always ask your lender to provide a cost comparison between a cash-out refinancing and a home equity loan.

I'm also recommending that you get professional tax advice and legal advice concerning how you own this home in conjunction with your mother. Who can use the mortgage interest deduction is one consideration; another is how the deed shows ownership of the property. Get this advice before you start shopping for your loan(s).

-- Posted: Feb. 14, 2002

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See Also
Everything you need to get a home equity loan
Cash-out refinancing -- here's how it works
No! Don't use your home equity to consolidate debt
More Dr. Don stories

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