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Sometimes it really makes sense to put all your eggs in one basket.
Debt consolidation can help you optimize your repayment plan and hopefully save you money in the long run. But when you use your home as collateral to secure your existing debt, there are a few more factors to consider – starting with the fact that default could cost you your home.
How to Consolidate Debt Using Equity
Debt can pile up quickly and you may be faced with many payments per month on mortgages, credit cards, and student loans.
“Most consumers are dealing with some kind of unsecured debt, and COVID has definitely made it harder to tackle that problem,” says Jeffrey Arevalo, a financial well-being expert at the company. Financial health GreenPath…
Consolidating your debt means taking one large loan and using it to pay off another existing debt. This way, you will only have one loan payment every month, ideally with a lower interest rate on that single loan than on other existing loans.
For example, if your credit card charges you 16% per annum on your lingering credit card debt and you consolidate that loan into a home equity line of credit at a rate of about 4%, then you are going to save some serious money on interest.
“For those who are struggling to pay their debts, are not moving fast enough, are paying high interest rates or are simply overwhelmed, I would consider debt consolidation,” says Arevalo.
For those who have a decent capital in their home, mortgage loan or home equity credit line (HELOC) can be good tools to consider – if you can qualify for them. Equity lending tightened in the past year, making it difficult to obtain these loans if you have a lower credit rating and less equity in your home.
BUT mortgage loan similar to a traditional loan: you receive a lump sum payment at the start of the term, then you receive monthly payments (plus interest) until you pay back what you borrowed. Equity line of credit more like a credit card. It’s a revolving line of credit, meaning you choose how much to spend on it and then have a repayment period to pay back what you borrowed (plus interest).
Is Using Home Equity For Debt Consolidation A Good Idea?
You should seriously consider your repayment plan and whether the underlying behavior that gave rise to your debt will continue before taking out a home equity loan or line of credit for debt consolidation.
“You have to be very careful about converting unsecured debt into secured debt,” says Arevalo. “If you hadn’t defaulted on a home equity loan or home equity line of credit, you could risk things like foreclosures.”
Yes, you risk losing your home if you don’t pay.
“I think it’s a dangerous world to borrow from home to pay with credit cards, because quite often we don’t change our behavior. We are just piling up all our debts in one huge pile, ”says Craig Lemoine, director of the Academy of Equity in Financial Planning at the University of Illinois.
But if you do it right and pay diligently, it can be a way to save money on paying off debt.
By taking high interest loans and combining them into a HELOC or home equity loan, you “could potentially save thousands of dollars a month,” says Darren K. English, Development Lending Specialist at Quontic.
Again, just make sure you consider the underlying circumstances that gave rise to your debt.
“If it turns out they can save a lot more money on interest, and they are willing to turn unsecured debt into secured debt, then a home equity loan would make sense,” Arevalo says. “But any behavior or circumstance that led to the accumulation of debt in the first place must be addressed.”
You will want to take a holistic approach to your situation to see if this strategy makes sense. Think about all your income and debts, what other recurring bills you pay, and your cash flow.
“Sometimes getting a loan or consolidation does not solve this basic problem. It might just be an adhesive plaster, ”says Arevalo.
Equity Loan vs HELOC for Debt Consolidation
The principles for using any debt consolidation product are the same: you take your HELOC or home equity loan, use it to pay off your existing debt, and then only worry about that existing loan.
A home loan is a more structured traditional loan. You will receive a lump sum against your home, Arevalo said, and usually consumers can use it to pay off their debts “fairly quickly.”
You will have a fixed interest rate on a home equity loan. This means that you will fix your interest rate at the beginning of the loan term, and it will not change.
On the other hand, HELOC offers a little more flexibility. This is similar to a credit card and therefore your payments will vary depending on how much you spend on your line. Your interest rate will also change based on the home loan, which means that if rates go up, you will be paid higher interest payments.
Particularly in the case of a secured real estate loan, it is more likely that you will have to pay closing costs and get an appraisal of your home, although some lenders require the same measures for HELOC. These will be cash expenses.
Pros and Cons of Using Home Equity for Debt Consolidation
Combine multiple debts into one payment
Save on interest
Repayment optimization (one payment to worry about, not many)
Converting Unsecured Debt to Secured Debt
You could lose your home if you don’t make the payment
May not match the ideal interest rate
You must have good credit and a decent amount of home equity to qualify for a home equity loan.
Debt Consolidation Alternatives
If you are considering debt consolidation but are not sure if it is right for you, go for a free consulting agency this might help you with your solution.
If you are concerned about converting your unsecured debt into a secured one, credit card with balance transfer might make sense. You can also get personal loan depending on how much debt you need to pay off. Both of these options have their pros and cons, so study them before diving into them.
Whichever you choose, just “be careful not to shift your debt to different places instead of dealing with it head-on,” says Arevalo.