Using a home equity loan for debt consolidation
Debt consolidation is one of the best methods for getting out of debt, especially if you have a lot of high-interest debt. Home equity loans are a particularly good tool for consolidating debt, since they usually come with low interest rates and long repayment timelines.
Is it a good idea to use home equity to consolidate debt?
Your home equity can be one of your most important assets; the more you build your home equity, the more cash you have access to through loans and lines of credit.
Many people turn to home equity to consolidate other types of debt, either through a home equity loan or a home equity line of credit (HELOC). This is because home equity loans generally have extremely low interest rates; for instance, you may be able to pay off 16 percent APR credit card debt with with a 4 percent APR home equity loan.
However, using home equity to consolidate debt is not the right choice for everyone. If you have a streak of late payments on a home equity loan, you run the risk of foreclosure. Additionally, you’ll need to have a decent amount of equity in your home in order to use it for debt consolidation.
Pros of using home equity for debt consolidation
Using your home equity for debt consolidation can be a smart move for a number of reasons.
One streamlined payment
When you consolidate your debt by using your home equity, you can simplify your life. Rather than many payments to worry about throughout the month, you’ll have one monthly bill to track. This can help you keep your finances streamlined.
Why this matters: Simplifying your finances is always a good thing. Having only one monthly payment decreases your odds of missing a payment.
Lower interest rate
A home equity loan generally comes with a lower interest rate than other types of loan products, since your home serves as collateral for the loan. If you have outstanding debt on a credit card, a personal loan, student loans or other debts, consolidating with a home equity loan could make it cheaper to pay off those debts.
Why this matters: A lower interest rate means less total interest paid over the course of the loan.
Make lower monthly payments
Using a home equity loan for debt consolidation will generally lower your monthly payments, since you’ll likely have a lower interest rate and a longer loan term. If you have a tight monthly budget, the money you save each month could be exactly what you need to get out of debt.
Why this matters: Lower monthly payments can make paying off debt more reasonable on a tight budget. However, it’s also worth noting that extending the length of your loan term could cause you to pay more interest overall.
Cons of using home equity for debt consolidation
While a home equity loan for debt consolidation might work for some people, it’s not necessarily the best choice for everyone.
Your home is collateral
The main consideration in using your home’s equity for debt consolidation is that your home serves as collateral for a home equity loan. This means that if you default on your new home equity loan, you may face home foreclosure. If you’re having trouble making existing payments, you may want to find other ways to consolidate debt.
Why this matters: A secured loan like a home equity loan means that if you fall behind on your payments, you may end up losing your home.
Increased debt load
While a home equity loan can consolidate your debt, it’s only helpful if you limit the spending that caused that debt to pile up in the first place. For instance, if you have a mountain of credit card debt, pay it off and then continue to rack up more credit card debt, you’re making your debt worse. Now you’ll owe a home equity loan payment as well as credit card payments.
Why this matters: Make sure that you’ve addressed the problems that caused you to go into debt in the first place. If you consolidate your debt before you’ve addressed the underlying concerns, you may find yourself right back where you started.
Possible fees and charges
Since a home equity loan uses your home’s current value, you may need to pay for a new appraisal of your home. Because a home equity loan is considered a second mortgage, you might be on the hook for closing costs as well. If you have a lot of debt to consolidate, paying these extra fees and charges may still make sense, but it’s wise to compare the fees you would have to pay with the amount you’d ultimately save in interest.
Why this matters: Make sure to that the fees of debt consolidation don’t outweigh the savings.
Other ways to consolidate debt
While a home equity loan is an option for debt consolidation, it’s not the only choice you have. Before choosing it, compare all of your options.
- Personal loans: Even though personal loans carry higher interest rates than home equity loans, they don’t carry the weight of your home with them. If an emergency comes up and you can’t make payments, you won’t lose your home through a personal loan.
- Balance transfer credit cards: If the majority of your debt is through credit cards, you can transfer your balances to a 0 percent APR credit card. These offers are typically temporary, but they might give you enough time to move your balances over and pay them off without the extra interest costs. Keep in mind that not all cards will approve your full balance; if you have lots of debt, you may still have to pay off some of your old cards with interest.
- Debt management plans: Nonprofit credit counseling agencies can work with you to create a plan that’s best for your finances. You’ll make one monthly payment to the counseling agency and then it’ll pay off your debt for you. It will negotiate your rate and payment with lenders so you can get on a plan that won’t put you in a financial bind.
How do I get started?
If you’ve decided that a home equity loan is your best option for consolidating debt, start off by comparing lenders, offers, rates and terms. If you can’t get better terms or a lower interest rate than what you currently have, keep looking at what other lenders offer. Having a plan for how you’ll attack high-interest debt — and how you’ll repay your home equity loan or HELOC — can set up your finances for a more secure future.
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