How to use a home equity loan to pay off high-interest debt
If you have been through some tough times recently-such as a job loss, major medical expenses or a traumatic event—you’re not alone.
While some may blame debt problems on irrational spending or poor saving habits, misfortune can wreck the best of plans.
If you’re a qualified homeowner, the good news is you might be able to use your home equity to consolidate debt.
Let’s take a look at how to determine whether this is the best solution for your financial needs.
Types of debt to consolidate using home equity
- High-interest debts
- Debt with large payments like auto loans that can take a huge bite out of your cash flow
When considering potential solutions, it is important to consider the reasons why you have accumulated a high amount of debt. Reach out to a Personal Banker to discuss opportunities that might meet your needs.
If your situation was caused by events beyond your control, then it might make good financial sense to use your house to help you recover.
Benefits of debt consolidation
Debt consolidation rolls several debts into one lower-interest payment. It’s a strategy you can use to reduce and reorganize your total debt to help you pay it down.
- Convert high-interest debt to lower-interest debt and save money on your monthly debt payments.
- Get more money with a home equity loan since loan limits can be higher than with personal loans
Improve your cash flow
When you consolidate those high interest, large payment bills into a lower interest loan with a longer term, you could see a cash flow improvement of several hundred dollars per month.
The savings you earn each month on monthly payments can either go towards paying down debt or to other needs in your budget. It can also be more efficient to make only one payment instead of several.
Figure out how much you can borrow, what your payment could be and how much you can save each month with the online calculators from Discover® Home Loans.
Simplify your monthly bills
By paying off your debt with a home equity loan, you can go from many bills to one monthly home equity loan payment. Streamlining your debt payment can help you manage your budget.
Risks of debt consolidation
There is a degree of risk involved whenever you take out a loan to pay off other debts. The key is to understand why you accumulated the debt.
You could lose your home
If the debt was due to uncontrollable circumstances, it could be prudent to use your home as collateral for a loan. However, some may caution against using home equity to pay off credit cards because of the risk of foreclosure.
Develop a solid repayment plan to mitigate the risk, such as using some of the monthly savings to pay off your new home equity loan more quickly.
Chance of running up additional debt
If you borrow to consolidate debt for a lower payment, you must be disciplined not to run your credit card balances up again. It is easy to rationalize each little expenditure, but the balance can grow quickly.
Depletion of your safety net
Equity in your home is one of your safety nets and a source of funds for important needs. Use it wisely.
Choosing the right type of home equity loan
If you decide to use your home equity to consolidate your high-interest debt, consider the two types of loans below:
Home equity loan
While the interest rates may be higher than those of a first mortgage, a home equity loan generally has much lower rates than credit cards or personal loans, and also offers low (or no) fees unlike first mortgages.
With Discover Home Loans, there are no application, origination, or appraisal fees, and no cash is required at closing.
A home equity loan typically has a fixed interest rate, so you won’t have to worry about rising rates. You pay it back in fixed monthly payments over a period of generally 10 to 30 years. This approach is good if you have a low rate on your underlying first mortgage that you don’t want to give up by using a cash out refinance.
Since a home equity line of credit (HELOC) usually has a variable rate and is designed for withdrawing funds periodically over time, a fixed rate home equity loan may be a better choice for debt consolidation.
Cash out refinance
You may be able to consolidate your debts and roll the money you borrow into your first mortgage with a lower rate using a cash out refinance.
Look at the interest rate you could get now compared to what you have, check out current interest rates, and calculate your potential savings. You should factor in the potential costs of refinancing when using this option.