While you can use a home equity loan to consolidate your debt, the big question is whether you should.
If you owe a lot of different creditors, you might want to consolidate it.
Debt consolidation involves taking out a new loan, hopefully at a lower interest rate, to help you pay off your current debt.
If you’re approved for your new loan, you’ll use the proceeds to pay off each creditor you currently owe money to. Instead of having many loans with several monthly payments and different interest rates, you will only have your new loan to pay.
For those who consolidate their debt, the big question is what type of new loan you are going to take out. Although you have many different options, a home equity loan is a popular choice. But before borrowing against your home, you should consider the pros and cons of consolidating debt using this type of loan.
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Benefits of consolidating debt with a home equity loan
With a home equity loan, your home serves as collateral. The amount you can borrow will depend on an appraisal of the home. The main benefits of consolidating debt with a home equity loan include:
- A low interest rate: Home equity loans tend to have a lower interest rate than almost all other types of loans. Using a home equity loan greatly facilitates qualifying for a loan that lowers your current debt rate.
- Lower monthly payments: In many cases, home equity loans are repaid over long periods of time. As a result, your monthly payment can be much lower than it would be if you kept your current debt or used another type of consolidation loan. Lowering your monthly payments can provide flexibility in your budget.
- A predictable payment process: As long as you get a fixed rate home loan, you’ll know the full cost of paying off your debt up front. And you will also know the repayment schedule so that you know the exact day your debt will be repaid.
Disadvantages of Consolidating Debt With a Home Loan
While these benefits can help make a home equity loan attractive, there are some drawbacks as well.
- Your interest is not necessarily tax deductible. Usually, mortgage interest is tax deductible if you itemize. However, home equity loan interest is only deductible in certain circumstances when you have used the debt to improve the home. While other types of debt consolidation loans also don’t come with deductible interest, it can still come as a surprise if you expect to be able to deduct it with your home equity loan.
- Costs and fees could be high: The upfront costs associated with obtaining a home equity loan tend to be higher than other types of loans. This can include the cost of an appraisal as well as loan origination fees.
- Getting a loan can take time: While you can often get approval for a personal loan or balance transfer within days or even hours, the home equity approval process can take weeks.
- You need equity in your home. Equity is the amount your home is worth minus what you owe on the mortgage. Many lenders only allow the combined total balance of your mortgage and home equity loan equal to 90% to 95% of your home’s value or less.
- You are putting your house in danger. Your home secures your equity loan. This means you could be kicked out if you miss payments. Other types of consolidation loans don’t put your home at risk like that.
For many people, these disadvantages outweigh the advantages. When this happens, personal loans or balance transfer credit cards become the best option for consolidating debt. If you are considering taking out a loan, be sure to carefully consider each new type of loan so that you can make an informed choice about what is best for you.