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How To Use Home Equity To Consolidate Your Debt

September 12th, 2018 7:07 AM by Jackie A. Graves

If you feel like you’re drowning in debt, you’re not alone. According to Experian’s State of Credit report, the average household has $24,706 in non-mortgage debt. That means things credit cards, medical bills or car loans. With such a heavy debt load and high interest rates, digging yourself out from that debt can be challenging.

That’s where debt consolidation can be a big help. And, if you own a home, tapping into your home equity instead of taking out a debt consolidation loan can be a smart choice. Learn more about how debt consolidation works and how to decide if it’s right for you.

What is debt consolidation?

Traditionally with debt consolidation loans, you work with a bank or other financial institution to take out a personal loan for the amount of your current outstanding debt. Once the lender approves you and disburses the loan, you use it to pay off your old debt.

Going forward, you have just one loan with one interest rate. The new loan has different terms than your old debt, such as repayment term, interest rate and minimum monthly payment.

Benefits of debt consolidation

There are several benefits to consolidating your debt.

1. You’ll have just one payment

If you previously had medical debt, credit card debt, a personal loan and a car loan, you know how frustrating and confusing it can be to keep track of multiple payment due dates. With so many to juggle, it’s easy to forget and fall behind.

By consolidating your debt, you have just one payment, rather than several. That makes it simpler to stay on top of your debt.

2. You’ll know when your debt will be paid off

With credit cards and other forms of debt, high interest rates can cause your debt to balloon. And because credit cards are revolving forms of debt — meaning you can continue using them and add to your balance — coming up with a payoff date can be tricky.

A debt consolidation loan streamlines the process. When you take out a loan, you have a set repayment term, such as three to five years. You can circle that date on your calendar and know that’s when you officially will be debt-free.

3. You can get a much lower interest rate

The average interest rate on variable-rate credit cards is 17.32 percent as of Sept. 5, according to Bankrate data, though they can often be much higher. With such a high interest rate, your debt balance can grow over time and you can end up owing far more than you originally charged.

By consolidating your debt, you can lock in a much lower interest rate. For example, you could consolidate your debt with a home equity loan — the current average interest rate on these loans is just 5.77 percent, according to Bankrate data. That way, more of your monthly payment goes toward the principal rather than interest charges.

4. You can save money

Debt consolidation can help you save a substantial amount of money. With a lower interest rate and set repayment term, the savings can be significant.

For example, pretend you had $10,000 in credit card debt at 15.54 percent interest. If you made only your minimum payments, you’d end up paying a total of $14,445. Thanks to interest fees, you’d have to pay an additional $4,445 to pay off your debt.

By contrast, say you consolidated your debt to a five-year home equity loan and qualified for a 5 percent interest rate. By the end of your loan, you’ll have repaid just $11,323. Taking just a few minutes to consolidate your debt would help you save over $3,000.

Use Bankrate’s debt consolidation calculator to find out how much you can save.

How to consolidate debt with home equity

Taking out a debt consolidation loan is one of the most common ways to consolidate debt. However, if you own your own home, there might be another way: You can tap into your home’s equity to better manage your debt.

Your home’s equity is its current value minus what you owe on your home. When it comes to a home equity loan or home equity line of credit (HELOC), you can typically borrow up to 80 percent of the equity. Depending on the lender, you can sometimes borrow up to 85 percent of your home’s equity.

For example, if you have a $300,000 home and owe $200,000 on it, your home’s equity is $100,000. At 80 percent cumulative loan-to-value, the total amount of outstanding borrowing would be limited to $240,000 ($300,000 x 0.80 = $240,000). You must retain 20 percent equity in the home, which is $60,000 ($300,000 x 0.60 = $60,000). So, subtract the amount you have to retain from your total equity, and you’d be able to borrow $40,000 ($100,000 - $60,000 = $40,000).

HELOC is a revolving line of credit rather than a lump sum loan. That means you can use the HELOC again and again as needed. A HELOC can give you greater flexibility for your future needs rather than a one-time, lump-sum debt consolidation loan. And, HELOCs are secured types of debt, meaning that your home secures the loan as a form of collateral. That difference can help you get a much lower interest rate than you’d get with other forms of loans.

If you decide to pursue a HELOC, you can apply for one with your local bank, credit union or online lender.

What to consider before tapping into your home equity to consolidate debt

Before moving forward with an application, there are some pros and cons of HELOCs to keep in mind.

1. HELOCs take time

Debt consolidation loans in the form of personal loans tend to be very fast. You can usually apply online within a few minutes, get approved nearly instantly and have the money deposited into your bank account within a few days.

HELOCs tend to take more time. It’s almost like a second mortgage on your home, so it takes a lot more paperwork and time to process before you can access your money. If you need the money right away, a traditional debt consolidation loan might be a better option for you.

2. HELOCs can be more risky

Debt consolidation loans are usually unsecured forms of debt, meaning that you don’t need to put down any form of collateral. If you fall behind on your payments, you can end up in collections and your credit score can be ruined, but your creditors can’t seize any of your assets or valuables.

HELOCs work differently. Because they’re secured by your home, missing your payments has more serious consequences. You could even lose your home. Only move forward with a HELOC if you can comfortably afford the payments.

3. There can be hefty fees

Home equity loans typically charge closing costs, while HELOCs typically charge low or no closing costs.

Depending on the bank you work with, you could face added charges like closing costs, appraisal fees and annual fees, all which can add to the cost of your loan. When shopping around for a lender, make sure you understand the closing costs each company charges and how it’ll affect how much you borrow.

4. You don’t get the tax benefits

Previously, you could deduct the interest you paid on a home equity loan or HELOC on your taxes, regardless of its use. However, the new tax law changed that. Now, you can deduct only the interest paid on your loan if you use the money to buy, build or renovate your home. Using a HELOC or home equity loan to pay off credit card debt does not qualify for the tax deduction.

HELOCs vs. debt consolidation loans

If you decide that a HELOC is right for you, it’s a smart idea to shop around with several different home equity loan lenders to ensure you get the best rates and terms.

Regardless of whether you select a HELOC or a debt consolidation loan, make sure you have a plan in place to pay off the debt as quickly as possible and avoid racking up credit card debt in the future. By coming up with a strategy, you’ll use your loan or HELOC wisely and set yourself up for a more secure financial future.

Source: To view the original article click here

Posted by Jackie A. Graves on September 12th, 2018 7:07 AM


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