Should you use a home equity loan for debt consolidation?

Debt consolidation loans are an effective way to eliminate those pesky debt balances faster. There are several types of debt consolidation loans to choose from, but a home equity loan might be ideal. It allows you to borrow against Equity in your homewhich is the difference between the current market value of your property and the amount you owe on your mortgage.

A home equity loan can mean you’ll get a lower interest rate than a personal loan and a longer payment period. If you can repay the loan and have good or excellent credit, a home equity loan may be a good option.

These loans aren’t without risk, however, so you need to weigh all your options to decide if a home equity loan is best for consolidating your debt.

Should I use a home loan to consolidate my debts?

Since home equity loans and home equity lines of credit (HELOCs) generally have low interest rates, they are good for homeowners who could save money by refinancing interest rate debt. high at a lower interest rate. For example, you might be able to pay off a 16% APR credit card with a 4% APR home loan.

Home equity loans and home equity lines of credit are best suited for those with significant equity in their home, usually at least 15-20%. The equity in your home can be one of your most important assets; the more you build, the more cash you have access to through loans and lines of credit.

“Borrowers who are serious about paying off their unsecured debt should consider a home equity loan for debt consolidation,” says Laura Sterling, vice president of marketing for Georgia’s Own Credit Union. “If a consumer has significant equity in their home, has the discipline to stay within their means when it comes to borrowing, and is in good financial health, this is usually a beneficial option.”

However, using home equity to consolidate debt isn’t the right choice for everyone, especially if you aren’t responsible for managing or paying off the debt. If you make late payments on a home loan, you could put your home at risk of foreclosure. And since most HELOCs have variable interest rates, you should plan for the possibility of higher monthly payments.

Benefits of Using Home Equity for Debt Consolidation

Using the equity in your home for debt consolidation can be a smart move for a number of reasons.

Simplified payment

When you consolidate your debt using the equity in your home, you can make your life easier.

“Many people struggle with juggling multiple bills each month and making sure they’re all paid on time,” says Joseph Toms, president and chief investment officer of Freedom Financial Asset Management, a debt relief firm. the debt. “Having only one payment to make can alleviate stress and help many people secure payment on time.”

Why it matters: Simplifying your finances is always a good thing. Having only one monthly payment decreases your chances of missing a payment.

Lower interest rate

A home equity loan usually carries a lower interest rate than other types of loan products because your home serves as collateral for the loan. If you have outstanding debt on a credit card, personal loan, student loans, or other debt, consolidating with a home equity loan could make paying off those debts less expensive.

Why it matters: A lower interest rate means less total interest paid over the life of the loan.

Make lower monthly payments

Using a home equity loan for debt consolidation will generally lower your monthly payments since you will likely have a lower interest rate and a longer loan term. If you have a tight monthly budget, the money you save each month might be just what you need to get out of debt.

Why it matters: Lower monthly payments can make paying off debt more reasonable on a tight budget. However, extending the term of your loan could result in you paying more interest overall.

Disadvantages of Using Home Equity for Debt Consolidation

While a home equity loan for debt consolidation may work for some people, it’s not necessarily the best choice for everyone.

Your home is guaranteed

The main consideration in using the equity in your home for debt consolidation is that your home serves as collateral for a home equity loan. This means that if you fail to repay your new home equity loan, you risk being foreclosed. If you’re having trouble making existing payments, you may want to find other ways to consolidate your debt.

Why it matters: A home equity loan is secured by your home, so if you fall behind on payments, you risk losing your home.

Increase in indebtedness

While a home equity loan can consolidate your debt, it’s only helpful if you limit the expenses that caused that debt to accumulate in the first place. For example, if you have a mountain of credit card debt, you pay it off, and you continue to rack up more credit card debt, you are making your debt worse. Now you will have to pay a home equity loan as well as credit card payments.

Why it matters: If you consolidate your debt before you resolve the underlying issues that led you into debt, you may find yourself back where you started.

Possible costs

Since a home equity loan uses the current value of your home to calculate how much you can borrow, you may have to pay for a new appraisal of your home. Because a home equity loan is considered a second mortgage, you may also have to pay closing costs. If you have a lot of debt to consolidate, paying that extra fee might still make sense, but it’s wise to compare the fees you’d have to pay with the amount you’d ultimately save in interest.

Why it matters: Make sure the debt consolidation fees don’t exceed the savings.

How can I get a home loan for debt consolidation?

The home equity loan and HELOC application process is similar to what you went through when you applied for a mortgage. These are usually:

  • Get pre-approved to assess your borrowing capacity
  • Complete a formal loan application
  • Submit income and employment information, as well as any additional documents the underwriter needs to process the loan application
  • Have your house appraised
  • Review and sign closing documents
  • Receive loan proceeds (home equity loan) or access a revolving line of credit (HELOC)

“The process can take up to 60 days, similar to a mortgage refinance,” says Vikram Gupta, home equity manager for PNC Bank. “At closing, the lender can often send debt payments directly to other lenders and consolidate the debt into the new home equity loan.”

Remember that the way you pay off a home equity loan and HELOC differs. With a home equity loan, the interest rate is fixed and you will pay in equal monthly installments over the life of the loan.

However, the interest rate on a HELOC is generally variable and the monthly payment can change over time. The loan begins with a drawdown period typically lasting 10 years, during which the borrower can draw on the line of credit as needed and pay only the interest. Once the draw period ends, the redemption period begins. The borrower then begins to pay both capital and interest for a term that generally lasts 20 years.

Sterling says that while HELOCs offer more flexibility, home equity loans offer the stability of fixed-rate payments for those who know how much they need to borrow.

Other Ways to Consolidate Debt

A home equity loan is not the only choice you have for debt consolidation. Before choosing it, compare all 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 arises and you can’t make payments, you won’t lose your home with a personal loan.
  • Balance transfer credit cards: If the majority of your debt comes from credit cards, you can transfer your balances to a balance transfer credit card at 0% APR. These offers are usually temporary, but they can give you plenty of time to move your balances and pay them off without the additional interest charges. Keep in mind that not all card issuers will approve your full balance; if you have a lot 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 best suits your finances. They’ll negotiate your rate and payment with lenders so you can get a plan that won’t put you in a financial bind. You will make a monthly payment to the counseling agency and then they will pay off your debt for you.

How to start?

If you’ve decided that a home equity loan is your best option for consolidating your debt, start by comparing lenders, offers, rates and terms. If you can’t get better terms or a lower interest rate than you have on your existing debt, keep looking at what other lenders are offering. Having a plan for how you’ll tackle high-interest debt — and how you’ll pay off your home equity loan, or HELOC — can prepare your finances for a more secure future.

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Nancy I. Romero