If you feel like you’re drowning in debt, you’re not alone. According to Experian’s State of Credit report, non-mortgage debt (credit cards, medical bills, car loans and the like) reached an average of $24,706 per household in 2017. With recent increases in the interest rate, getting out of debt has become more and more of a challenge.
That’s where debt consolidation can be a big help. And, if you’re a homeowner, taking out a home equity loan for debt consolidation can be a smart choice.
When you have enough equity in your home, consolidation loans might be worth considering as an alternative to personal loans or balance transfer credit cards. Learn more about how the process works and how to decide if it’s right for you.
4 benefits of debt consolidation through home equity
A home equity loan or a home equity line of credit (HELOC) can help you tap into your home equity to borrow money.
Unlike a home equity loan, a HELOC is a revolving line of credit rather than a lump sum. That means you can use the funds over time as you need them. Whether you use a HELOC or a home loan, consolidation of your debts through home equity borrowing offers several benefits.
1. You’ll have just one payment
If you previously had medical debt, credit card debt, a personal loan and a car loan, you know how confusing it can be to keep track of multiple payment due dates. By consolidating your debt, you have just one payment, rather than several.
2. You’ll know when your debt will be paid off
Because credit cards are revolving forms of debt — meaning you can continue using them and add to your balance — coming up with a payoff date can be tricky. A debt consolidation loan streamlines the process. When you take out a loan, you have a set repayment term, such as three to five years. You can circle that date on your calendar and know that’s when you officially will be debt-free.
3. You can get a much lower interest rate
The average interest rate on variable-rate credit cards was 17.32 percent in September 2018, according to Bankrate data. By consolidating your debt, you can lock in a much lower interest rate. For example, you could consolidate your debt with a home equity loan — the September 2018 average interest rate on these loans is under 6 percent, according to Bankrate data. That way, more of your monthly payment goes toward the principal rather than interest charges.
4. You can save money
Imagine you had $10,000 in credit card debt at 15.54 percent interest. If you made only your minimum payments, you’d end up paying a total of $14,445. By contrast, say you consolidated your debt to a five-year home equity loan and qualified for a 5 percent interest rate. By the end of your loan, you’ll have repaid just $11,323. A HELOC or home loan consolidation could help you save over $3,000.
Use Bankrate’s Debt Consolidation Calculator to find out how much you could save.
How to consolidate debt with home equity
Taking out a loan is one of the most common ways to consolidate debt. However, if you own your own home, consolidation loans offer a new wrinkle: You can tap into your home’s equity to better manage your debt.
Your home’s equity is its current value minus what you owe. When it comes to a home equity loan or HELOC, you can typically borrow up to 80 percent of the equity. Depending on the lender, you can sometimes borrow up to 85 percent.
Home equity loans and HELOCs are secured types of debt, meaning that your home secures the loan as a form of collateral. That difference can help you get a much lower interest rate than you’d get with other forms of loans.
If you decide to pursue a HELOC or home equity loan for debt consolidation, you can apply with your bank or credit union or an online lender.
Note the drawbacks of a home equity loan for debt consolidation
Whether it’s a HELOC or a home loan, consolidation of debt through home equity borrowing can get complicated. Consider the pros and cons before you start making applications.
A time-consuming process
Home equity loans and HELOCs tend to take much more time than personal loans. It’s almost like a second mortgage on your home, so it takes a lot more paperwork and time to process before you can access your money. If you need the money right away, a personal loan might be a better option for you.
The element of risk
HELOCs and home equity loans are forms of secured debt that use your home as collateral. As a result, missing payments or defaulting can have more serious consequences. You could even lose your home. Move forward with a HELOC or home equity loan only if you can comfortably afford the payments.
Fees and closing costs
Depending on the lender you work with, you could face charges like closing costs and appraisal fees, all which can add to the cost of your loan. When shopping around for a lender, make sure you understand the closing costs each company charges and how it’ll affect how much you borrow.
Absence of tax benefits
Previously, you could deduct the interest you paid on a home equity loan or HELOC on your taxes, regardless of its use. However, the 2018 tax reform bill changed that. Now, you can deduct only the interest paid on your loan if you use the money to buy, build or renovate. Using a HELOC or home equity loan to pay off credit card debt does not qualify for the tax deduction.
What to do when borrowing isn’t an option
What if you don’t own a home or have good enough credit to get a personal loan at an interest rate you can afford?
People with serious debt and credit problems may want to consider debt relief programs. Pros and cons of some various debt relief options include:
Debt management plan
Agreeing to a debt management plan with a credit-counseling agency won’t hurt your credit score, but it requires that you close all accounts included in the plan. In the case of credit card debt, that requirement means you would have to part with your plastic.
The good news is that you make monthly payments to the agency, which in turn makes payments to your creditors. If you have debts with multiple credit cards or lenders, you’ll be saved the hassle of tracking multiple bills and due dates.
Debt settlement plan
The main upside of a debt settlement plan is agreeing to settle with one or more creditors for less than what you owe. As the trade-off, however, your credit score will suffer significantly.
You’ll also have to pay fees and taxes, a consideration that might make debt management a less drastic option.
Shop around and stick to your strategy
It’s a smart idea to shop around with several different home equity loan lenders to ensure you get the best rates and terms.
Whether you select a HELOC or a home loan, consolidation through home equity borrowing makes sense only if have a plan in place to pay off the debt as quickly as possible. You’ll also need to avoid racking up credit card debt in the future.
By coming up with a strategy, you’ll use your loan or HELOC wisely and set yourself up for a more secure financial future.
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