Should You Use a Home Equity Loan to Consolidate Your Debt?

A convenient way to increase the value of your home and access cash at a low interest rate is with a home equity loan. Taking out a home equity loan means you are borrowing against the mortgage Equity you have built up in your home (The more mortgage payments you make, the more equity you eventually have). The value of your home secures the loan, so a bank or lender will feel comfortable giving you a large line of credit.

Lenders typically want to see that you have at least 15% to 20% equity in your home before they approve you for a home equity loan. Once approved, you can either receive the money as a lump sum that you pay back at a fixed rate with payments remaining the same, or when You use a home equity line of creditor HELOC, you can keep a revolving line of credit open for years and withdraw from it at will, but your Interest rate will rise and fall over time.

Currently, home equity rates are just under 7%, meaning they’re a cheaper option than other forms of financing like credit cards or personal loans (which currently average 10.7%, according to CNET’s sister site, Bankrate).

Read on to learn more about the Pros and cons of using a home equity loan (commonly referred to as a second mortgage) for debt consolidation, as well as alternative ways to reduce debt and get your finances back on track.

Should You Use Home Equity to Consolidate Debt?

Some of the reasons to borrow against your home equity loan to consolidate debt is to pay off higher-interest consumer debt, such as credit cards or student loans. Basically, you can use the money for whatever you want – so it’s important to make sure you can manage your money responsibly, such a large line of credit over a period of time. If you are tempted to use your home loan B. for vacations or non-essential life events, instead of paying off your debt – and keeping it low – this may not be the right solution for you.

Benefits of using equity for debt consolidation

Home Loans & HELOCs allow you to use home ownership by releasing the equity of your property as cash. They can also give you quick access to the money within a month or two.

Low interest rate

Home equity loans typically have low interest rates, which saves you money over the life of your loan. For example, if you have a 21% APR on your credit card, you can pay it off with a 7% HELOC, saving you thousands of dollars in interest over the life of your loan.

A lower monthly payment

Combining all of your debt into one monthly payment makes paying off your debt a more manageable and efficient process, and should reduce the amount you pay each month.

Tax deduction for home renovations

If you use your home equity loan to renovate or repair your home, you can deduct it on your taxes.

Disadvantages of using equity for debt consolidation

Make sure you are ready for the responsibility of managing a large sum of cash over a period of years. If you use your equity loan or HELOC Pay off credit card debt, but don’t change your behavior and financial habits, you’ll end up in debt right back and your house will be at stake – not just yours credit-worthiness. Because of this, it’s important to be thoughtful and sensible about when and why you take out a loan against the value of your home.

You can lose your home

The most obvious downside to a home equity loan is that if for some reason you don’t make payments or default on your loan, your bank or lender can repossess your property.

A home equity loan can increase your debt

If you don’t manage your credit and other debt properly in the future, you can end up in even more debt. As in, if you pay off credit card debt but don’t change your spending habits, you will face credit card payments in addition to your home equity payments, which negates the reason for taking out the loan in the first place.

loan limits

if you have one low or less than excellent credit historyor you already have a lot of debt, you may not have access to a very large amount of credit, and the interest rate that a lender will charge you will also likely be higher.

Alternative ways to debt consolidation

Before committing to a home equity loan, or HELOC, and risking your home, consider the other types of financing available to you. Instead of taking out a second mortgage, you can consider options like a Credit card with 0% interest or a personal loan that doesn’t come with the risk of losing your home – although they may come with higher interest rates as they are unsecured loans.

Balance transfer credit cards

Such Fund Transfer Credit Cards typically offer a 0% interest rate for an introductory period that can range from six to 21 months. After that, your interest rate goes up and you pay a higher APR.

Personal Loans

You can apply for a personal loan from a bank or other financial institution. You may pay a higher interest rate, but you don’t have to put your home up as collateral the loan.

Total Debt Management

Another possibility is enter credit counseling. You can work with a nonprofit agency that charges little to no fees and your credit score won’t be negatively impacted. Advisory services can negotiate lower balances and interest rates with your creditors on your behalf and create a plan that will keep you out of debt. Beware of debt consolidation scams and make sure you are working with a reputable organization if you are going down this route.

How to apply for a home loan for debt consolidation

To qualify for a home equity loan, you must be approved by a bank or lender. Lenders usually want to see that you have at least 15% to 20% built up in your home. If you have enough equity, lenders then want proof that you are creditworthy and able to repay the loan. Lenders usually charge a minimum credit-worthiness of 620 (the higher your score, the better your chances of loan approval and at a lower interest rate), a debt-to-income ratio of 43% or less, and proof of income, among other types of financial documents. You may also need to pay for a new home appraisal to get an accurate and up-to-date appraisal the current market value of your home.

The final result

A home equity loan can help you consolidate and pay off debt at a lower interest rate, but you must weigh the pros and cons of using your home as collateral for a loan. As long as you make payments on time and keep paying off your debt, home equity loans can be an inexpensive way to increase the value of your home.

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