Pros and Cons of Using a Home Equity Loan to Consolidate Debt
If you owe money to many different creditors, you might be interested in consolidating it.
Debt consolidation is taking out a new loan, hopefully with a lower interest rate, to help you pay off your current debt.
If your new loan is approved, you will use the proceeds to pay off any creditors 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 will 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 advantages of consolidating debt with a home equity loan are as follows:
- 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 makes it much easier to qualify for a loan that lowers your current debt rate.
- Lower monthly payments: In many cases, home equity loans are paid off over long periods of time. Therefore, 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 equity 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 Equity 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 do not come with deductible interest, it may still be surprising if you expect to be able to deduct them with your home equity loan.
- Costs and fees could be high: There are generally more upfront costs associated with obtaining a home equity loan 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 the equity in your home. Equity is the value of your home minus what you owe on the mortgage. Many lenders only allow the combined total balance of your mortgage and home equity loan equal to or less than 90% to 95% of your home’s value.
- You are putting your house in danger. Your home secures your equity loan. This means you could be kicked out if you miss payments. The other types of consolidation loans do not put your home in jeopardy like this one.
For many people, these disadvantages outweigh the advantages. When this happens, personal loans or balance transfer credit cards end up being 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.