Do you want to take control of your financial future? For the average person, that journey has to start with eliminating debt. Consolidating debt into one monthly payment, often with a lower interest rate, can help. For homeowners, a home equity loan for debt consolidation can offer the best interest rate. Learn more about how you can use home equity loans for debt consolidation.
How Can a Home Equity Loan Help Me Consolidate Debt?
Debt consolidation is a form of debt refinancing where you combine all of your debts into one, affordable monthly payment. You can use debt consolidation for credit card, auto, retail, and student loan debt. If you get a home equity loan for debt consolidation, you cash out the equity in your home to pay off your debt. While you’ll need to make a fixed monthly payment, the interest rates are often lower than credit card or personal loan interest, saving you money.
What Is a Home Equity Loan?
With a home equity loan, a homeowner borrows a lump sum of cash against the equity in their home. The homeowner pays down this loan with monthly payments, on top of the original mortgage. This differs slightly from a home equity line of credit (HELOC), which is another method for accessing the equity in your home – using a revolving line of credit rather than a lump sum. You can calculate your home equity by taking the outstanding balance of your loan and subtracting it from the value of your home. Calculate your current home equity with the following formula:
The current appraised value of the home – mortgage balance = home equity
A quick example: $300,000 appraisal – $180,000 mortgage balance = $120,000 in home equity
Advantages of a Home Equity Loan
A home equity loan debt consolidation offers the following advantages:
- Lower interest rate: Because a home equity loan is secured by your home, it often has a lower interest rate than other options, like personal loans. If your home equity loan’s interest rate is less than your debt’s interest rate, you could save money in the long run. A home equity loan also comes with a fixed interest rate. Depending on the current interest rate of your debt and the amount of debt owed, this could result in significant cost savings over the life of the loan.
- Single monthly payment: One monthly payment can be easier to manage than multiple, monthly debt payments.
- Lower payments: Consolidating your debt into one monthly payment with one interest rate can reduce how much of your income goes to servicing debt obligations.
- Tax-deductible: Because home equity loans can be tax-deductible in some situations and credit card interest is not, this could also save you money.
Disadvantages of a Home Equity Loan
It is necessary to also be aware of the requirements, and potential cons, of a home equity loan.
- Potential for foreclosure: A home equity loan is secured by your home. That means that missing payments could potentially lead to a foreclosure. It’s crucial to make sure you can make the monthly payments.
Possible impact on your credit: Missing payments can also damage your credit, making it harder to be approved for other types of financial products.
- Adding another monthly payment: Rolling debt into a home equity loan also spreads the debt out into a set number of years, at a fixed monthly payment. With lower interest rates, you could save money over the life of the loan, but you will have to make another monthly payment to the loan.
Although a home equity loan for debt consolidation can be a useful tool, it’s not for everyone.
What Is a Home Equity Line of Credit (HELOC)?
A HELOC is a loan, or a line of credit, that allows you to borrow against your home’s equity. Like a credit card, once you are approved, you withdraw cash when you want and pay back only what you use. With a HELOC, you only pay interest on the money that you’ve taken ou during the draw period, which typically lasts ten years.
Because you have revolving credit, you can take out only how much you need at a time, which may be good for homeowners consolidating anticipated debt, like future large investments, or ongoing debt, like long-term bills being paid down. This type of loan comes with a variable interest rate, meaning it can change over time. Typically, the draw period is followed by a twenty-year repayment period, during which you’ll make payments on your full balance.
Additional Methods for Consolidating Debt
Depending on your debt repayment needs and credit eligibility, you may explore other options to consolidate your debt, including:
- Home equity investment: With a Home Equity Investment (HEI), you can tap into your existing and future home equity to receive funds up to $350,000, with no monthly payments.
- Personal loan: Personal loans may help you consolidate debt, but they often come with higher interest rates and shorter repayment times.
- Cash-out refinance: A cash-out refinance refreshes your existing mortgage, sometimes offering you a lower interest rate. This may allow you to reduce your monthly mortgage payment, while also collecting funds by cashing out your equity.
- Credit card balance transfer: A credit card balance transfer allows you to move your debt from one or more credit cards to another, usually with lower interest rates. But, these rates are often temporary, and your credit score will likely decrease as a result.
- Debt settlement: Debt settlement can be helpful in negotiating your debt. A negotiator will work with your creditors to negotiate a lower payment amount than what is owed.
How to Start the Home Equity Loan Process
If you decide that a home equity loan is right for consolidating your debt, then you can get started with the following steps:
- Calculate how much you need: Use a HELOC calculator to determine how much you need to pay off your debt. Lenders do not allow you to take more than the equity available in your home. Additionally, most lenders will also not allow you to take the full equity, usually limiting it to a maximum of between 75% and 80%.
- Consider your equity: You will also need to calculate your equity to determine how much you can cash out.
- Consider your interest rate: Consider the current interest rate of your debt as well as the interest rate of any potential home equity loans to determine which interest rate is cheaper.
- Shop lenders: Request information on eligibility requirements and financing requirements, including lending fees and any other costs involved.
- Determine eligibility: Home equity loans have certain eligibility requirements that you need to meet, including a good credit score, a good debt-to-income ratio, a good loan-to-value ratio, and solid employment history.
Because most homes increase in value over time, many homeowners have equity available. Point, a product that allows you to tap into your current and future potential equity, may be a solution for debt consolidation. With no monthly payments and the ability to maintain control over your home, an HEI can be an effective solution for homeowners looking to eliminate debt quickly. You can qualify for an HEI even if you’ve been rejected for conventional financial products. Contact us to learn more about HEIs and how they can help you get a financial fresh start.Tags: Home Equity