A home equity debt consolidation loan can be great if you avoid the disadvantages. You can pay off many debts at once, leaving you with just one loan payment each month so you could start saving or investing in something else. If you use a home equity loan to consolidate those debts, your interest rate will also be lower. Depending on the length of the loan, you could save a lot of time and money as a result.
The unsecured loan options are the offers you usually get in the mail from various finance companies. In most cases, they advertise a low rate which shoots up to a rate that’s even higher than most of your current debts’ rates if you’re ever late on a payment. It’s best to avoid this type of consolidation loan if at all possible.
For this reason, our discussion of the advantages and disadvantages of debt consolidation will be limited to the secured options, like home equity loans.
Since we have mentioned home equity loans, let’s explain a bit about them.
Learn About Home Equity Loans
Home equity loans are quite simple to understand. It’s a loan that is secured by the equity that exists in your house or condominium. If you’ve ever heard the term “second mortgage,” you’re familiar with home equity loans.
Home equity loans can be a great way to tap into your equity and put that value to work for you. Whether you’d like to pay off your credit card bills, invest in a rental property, or take a trip, a home equity loan can help you achieve those objectives.
There are 2 types of home equity loans:
- Traditional. You receive a lump sum and make payments on the loan, just as you would on any other installment loan. The interest rate is usually fixed.
- The advantages are a predictable payment and interest rate. This is a great loan for debt consolidation or any big-ticket items.
- Home equity line of credit (HELOC). This is more similar to a credit card. You can use any amount you need, up to your credit limit. The interest rate is usually variable.
- A HELOC is great when flexibility is most important to you. You also only pay interest on the money you actually borrow. You can use the money whenever you need it.
Consider which type of loan is most supportive of your situation. Each type of loan can be a viable choice, depending on the circumstances.
Facts about home equity loans
There are differences from traditional mortgages.
Home equity loans are much quicker to process than traditional mortgages. The fees are quite low, too. A traditional home equity loan can probably be secured for just a few hundred dollars. HELOCs are frequently free to acquire.
Remember that the amount of equity in your home varies.
Depending on what the market is doing, the value of your house is constantly in flux. When the value drops, the amount of equity in your home drops, too.
A HELOC can actually be canceled if your equity drops too much. This is one advantage of the traditional-style loan. Once you have the loan, any change in home equity is irrelevant, at least from the standpoint of acquiring the loan.
Balloon payments can be part of the loan.
Many home equity loans are set up to mimic the payments of a 30-year mortgage, even though the loan may only be for 10 years. This means that you’ll be forced to make a balloon payment at the end of that time. Be sure to include this fact in your decision-making process.
Foreclosure is a risk.
Remember that the loan is secured against the equity in your home. If you fail to make your payment, the lender can foreclose on your home to recoup the money that was lent.
The interest rates are very good, but not as good as a first mortgage.
- Since the loan is well secured, lenders are able to offer good interest rates. But the loans are junior to the primary mortgage.
- If you stop making all of your payments, the primary lender will get their money back first. The home equity lender can only get its share from whatever is left over, which might not be enough. Remember that the amount of equity in your home varies.
Now that we have covered some basics of home equity loans, let’s get back to the real subject in hands. Should you get it as a consolidation loan?
Advantages of a Home Equity Debt Consolidation loan
- A single payment. It’s certainly a lot simpler and more convenient to make a single monthly debt payment. You can even easily arrange to have the funds deducted from your bank account each month. This can be a real advantage if you struggle to stay organized.
- A lower interest rate. If the loan is being used to pay credit card debt, the interest rate can be much, much lower. Since a home equity loan is secured by your home, the interest rate is about the best you’re ever going to find.
- Lower payments. The lower interest rates coupled with the typically longer loan period will result in lower payments, possibly much lower. For your best long-term savings, though, set up the loan payback period to as short a time as you can.
- A single creditor. If you ever run into challenges with making your payment, there is only one creditor to deal with. You no longer have to get on the phone and call many different creditors to try and straighten things out.
- Taxes. In most cases, your home equity interest is tax deductible. Do your research to see if this tax break applies to your situation. This is much better than paying interest on your credit cards.
Disadvantages of a Home Equity Debt Consolidation loan
- The potential for greater debt. It can be hard to avoid the temptation to start charging items to your credit cards once the balances are paid off with the consolidation loan. As you can imagine, this can be a serious challenge as your balances climb again. Don’t make your situation even worse.
- The length of the loan. This is manageable, but people frequently take out a loan that is anywhere from 10 to 25 years. This dramatically increases the total amount you’ll pay in interest. Avoid getting a loan for a longer period of time than you really need; you can really negate a lot of the advantage of the loan.
- Your house is at risk. Do you know what happens when you don’t pay your credit cards? You get a lot of phone calls, nasty mail, and there is a very slight chance you’ll be sued a few years down the road.
- Do you know what happens when you don’t make your payments on your home equity loan? They come after your house. You got that great interest rate because your house served as collateral for the loan. Your house is truly at risk if you don’t live up to your loan obligations.
Home equity debt consolidation loans can be wonderful if you have the self-discipline to:
- Borrow only what you really need.
- Avoid incurring more debt.
- Keep the payment period as short as you possibly can.
- Make your payments on time.
Home Equity Debt Consolidation Loan: Yes or No?
Borrowing money isn’t always the best option, but you have to do it if you haven’t put a good budgeting plan to save some money.
If you need to borrow money, a home equity loan might be perfect for your needs. The interest rate is very good, and home equity loans can provide a lot of flexibility for any financial purpose. Shop around for the best rates and terms.
If you can do all these things, a home equity debt consolidation loan can save you a lot of money and grief in paying off your debts. As with any financial service, be sure to look around for the best rates before you take the plunge.