Should You Use a Home Equity Loan for Debt Consolidation?
Many people use home equity loans to consolidate debt and achieve other goals. If you’re thinking about using a home equity loan to consolidate debt, there are some important things to consider. The following overview can help you decide whether this strategy makes sense for your financial situation.
Benefits of Using a Home Equity Loan for Debt Consolidation
Many people assume home equity loans are only for home improvements or other projects, but utilizing the equity in your home to refinance other debt may make sense depending on your situation.
You May Get a Lower Interest Rate
Home equity loans often have lower rates than other borrowing options. This is because your home is used as collateral. The interest rate may be significantly lower than your current debts, like credit cards.
You Will Have One Monthly Payment
Keeping up with multiple payments each month can be confusing as each debt may have a different due date. If you accidentally miss a payment, you could get hit with an expensive late fee. It will also be reported to the credit reporting bureaus, which will negatively affect your credit score.
If you consolidate your debt with a home equity loan, you will only have one payment to keep up with each month. This helps to simplify your budget.
If you have multiple credit card payments each month, for example, you can use a home equity loan to pay off the card balances. Depending on the card issuers, you may be able to save money on interest, and your finances will be simplified with one monthly payment.
It May Help You Lower Your Monthly Payments
Your monthly payments may be lower if your new loan has a lower interest rate. Also, your overall debt payments could be reduced by consolidating several payments into one. You may also have a longer repayment period with your new loan. The longer you take to repay a loan, the lower your payments will be.
You Could Pay Off Your Debt Sooner
Using a home equity loan to consolidate your debt could help you to pay it off sooner. If you are struggling to pay off high-interest credit card debt, for example, a new loan with a fixed term may be easier to manage.
The structured payments will help you see the light at the end of the tunnel when your current payments don’t reduce your balance much because of the high interest rate. Also, if you can make additional payments on your home equity loan, it could help you repay your debt months or even years sooner.
You Can Refinance a Traditional Mortgage
If you have a mortgage, you can use your home’s equity to refinance with a home equity loan. Even if the interest rate on the new loan is the same or higher than your mortgage, you may be able to save money by no longer having to pay for PMI.
Negatives of Using a Home Equity Loan for Debt Consolidation
The potential negatives of using a home equity loan for debt consolidation may outweigh the benefits depending on your financial situation. Be sure to carefully consider these factors before making a borrowing decision.
You Risk Foreclosure on Your Home If You Can’t Pay
Your home will be used as collateral if you’re approved for a home equity loan. If something happens that causes you to default on the loan, there’s a chance that your lender may foreclose on the property and sell it to recoup the money you were loaned.
It Doesn’t Fix Bad Spending Habits
A debt consolidation loan may not be beneficial if you continue with the spending habits that caused you to accumulate excessive debt. For example: If you consolidate multiple credit cards and don’t make any changes to your spending habits, you may end up in debt again.
How to Get a Home Equity Loan
You can get a home equity loan from a bank, credit union, or another private lender. Because credit unions are nonprofit organizations, they tend to offer the best interest rates. Applying for a home equity loan is relatively easy when you follow these steps.
1. Check Your Credit Score
Your credit score is an important factor that lenders will consider when evaluating you for a loan. There are some things you may be able to do to improve your score if you believe yours could be stronger, although it may take a few months to see improvements.
2. Determine How Much Home Equity You Have
Home equity is the amount of your home that you own. It is your home’s current market value less the amount you still owe on your mortgage. You can estimate your home’s market value by checking out the prices of comparable homes in your community.
3. Apply for a Home Equity Loan
When applying for a home equity loan, be sure to tell your lender that you want to use it to consolidate debt. A lender may be hesitant to approve a loan if you already have a lot of debt, but if you explain the purpose of the loan, it may increase your chances of loan approval.
Home Equity Loan Alternatives
A home equity loan may not always be the best choice when it comes to debt consolidation. Depending on your financial situation, one of the following alternatives may be a better choice.
Personal loans are similar to home equity loans in how they’re structured. The primary difference is that personal loans are not backed with collateral. Because of this, they usually have higher interest rates. On the other hand, personal loans don’t tend to have closing costs.
Cash-Out Mortgage Refinance
A cash-out refinance is a type of loan where you refinance your current home. With your new mortgage, you will borrow more than the payoff amount on your home. The additional money you borrow can be used for nearly any purpose, including consolidating debt.
A cash-out refinance typically only makes sense if you can get a better interest rate than your original mortgage. Also, because you will be obtaining a new mortgage, you will have to pay closing costs, which are typically 25 to 5% of the loan amount.
0% Balance Transfer Card
Many credit cards offer special promotions where you can transfer existing credit card debt to a new card just for signing up. You aren’t required to pay any interest on the balance for an introductory period, which may be 12 to 18 months. This strategy may be a good option if you know you can pay off your debts during the introductory period.
Requirements for Home Equity Loans
Before you apply for a home equity loan, it’s important to carefully consider the requirements to make sure you have a strong chance of loan approval. Click below to learn more about what you need to qualify for a home equity loan and successfully pay it off.