The typical, home-owning family has a long-term mortgage with a relatively low interest rate. At the same time, many of these households carry other debts, such as student loans, car loans, and credit card balances. These may be at significantly higher interest rates.
As these homeowners pay monthly bills and see that significant amounts of their payments are going to interest, they might realize the benefit to consolidating debt into just one or a few loans with lower interest, allowing them to pay off debt faster. There are actually several choices for debt consolidation, including leveraging home equity.
Equity is the difference between the market value of a home and the outstanding mortgage balance. Once this amount is greater than fifteen to twenty percent of the value of the home, refinancing, home equity loans and home equity lines of credit (HELOCs) are worth considering. These loan options permit using equity as security for a loan and applying the loan proceeds for other needs. Debt consolidation is one important way people choose to use the cash from their home equity loan.
Before you follow the path of using home equity products for debt consolidation, consider the possible risks of tapping into the value of your home to secure a loan. Think about these pros and cons.
Pros of home equity loans, HELOCs and refinancing:
- These loans are secured by something with tangible value (your home), so they generally offer interest rates that are lower than revolving debt such as credit cards.
- Because of lower interest rates, the related monthly payment for an equity loan can be significantly lower than that for credit cards.
- Home equity loans may have lower fees. Discover Home Loans, for example, have no application fees, origination fees, and don’t require cash at closing.
- Loan limits may be higher than for other consolidation options such as personal loans or credit card consolidations.
- Fixed home equity loans can be set up with a predictable fixed monthly payment, providing some help for budgeting.
- Consolidating from multiple payments to multiple lenders at different times to a single payment to one lender once a month can lower the overall amount of money going out the door. It can also help borrowers avoid missing a payment or paying late. This can prevent fees and possible adverse credit score impacts. Use a debt consolidation calculator to see how going from multiple payments to one may help you.
Cons of home equity loans, HELOCs and refinancing:
- These secured loans use your home as collateral, meaning that missed payments can put the borrower’s home at risk.
- Approval of home equity loans can take several weeks. Be sure to stay current with all payments during the wait time if you do apply for a loan.
- Consolidation to a single obligation with a lower monthly payment can give a false sense of security. If borrowers don’t change existing bad debt habits and actually start saving instead of spending, the debt can grow.
- These long loans may actually add up to a greater total interest paid over the length of the loan, depending on the length of the loan vs other debt. Discover Home Loans offers loans of 10, 15, 20 and 30 years.
- If home values in the community decline, using a large part of the equity in a home can put the borrower “under water” on the loan, meaning the homeowner owes more than the home is worth.
Debt consolidation can ultimately put you on the right track to financial health. Do your research to understand the pros and cons of these options and then make the best decision for your personal situation.