How Can A Home Equity Loan Help Pay Down Debt?
Home equity loans are typically structured as a second mortgage that unlocks the monetary difference between your first mortgage and the present-day value of your home. There are a couple of ways these loans can be set up, with each providing you potential access to thousands of dollars, but in far different ways.
While the different types of home equity loans can provide a low-interest method of debt consolidation for consumer debts such as credit cards, high-interest auto loans, or collections accounts, there are some important considerations to keep in mind before signing the dotted line. This article will cover how home equity loans work and whether or not they’re the best option for you to get debt relief.
What Types Of Home Equity Loans Are Available?
The first thing to consider when it comes to getting a home equity loan is how the money from the loan will be dispersed to you. This will be determined by the type of home equity loan you get—either a cash-out refinance, cash-out second mortgage, or a Home Equity Line Of Credit (often referred to as a HELOC).
Cash-Out First Mortgage Refinance
With a cash-out refinance, you get a whole new first mortgage on your home that pays off your current mortgage and provides you a lump-sum check at the closing table. This means you wind up with a higher first-mortgage balance than you currently have, and depending on the loan term you choose, you may also wind up paying on a first mortgage for many more years.
Cash-Out Second Mortgage
Cash-out second mortgages allow you to keep your first mortgage while still accessing the equity in your home. Typically, second mortgages come with higher interest rates than first mortgages because the lender must take on more risk.
That said, the rates are still usually far better than what you’re paying on credit card debt. As with cash-out first mortgages, you get a lump-sum check at the closing table that you can do with whatever you please.
One exception is if you have a high debt-to-income ratio, in which case the lender may require some of the funds to be distributed to your other creditors to pay down your monthly payments to an acceptable level.
Home Equity Line Of Credit
Home equity lines of credit (HELOC) work differently than cash-out first and second mortgages. HELOCs are second mortgages, but instead of getting a big check at the closing table, you instead get a checkbook that you can write checks from to pay down your debts.
The benefit of a HELOC over a traditional mortgage is that you only pay interest on the amount you use. For example, if you’re approved for a HELOC that allows you to access $100,000 of your home’s equity but you write checks out of the account for only $50,000, you only have to pay interest on the $50,000.
One drawback to HELOCs is they typically have higher interest rates than first mortgages, and sometimes the rates are adjustable and tied to a floating index such as the LIBOR (London Interbank Overnight Rate).
Is A Home Equity Loan Good For Consolidating Debt?
In general, home equity loans come with many financial benefits, such as reducing your interest rates, the possibility of writing off the interest on your taxes each year, and significant reductions in your monthly debt payments.
One good rule of thumb to keep in mind is that the best home equity loans are designed for borrowers who have significant equity available in their homes, usually 20 percent or greater. While some home equity loans will allow you to borrow up to 100% of the value of your home, the rates can be much higher, so it’s best to borrow only what you need.
Tapping the equity in your home to consolidate your debts isn’t always the most beneficial choice for everyone, especially those who have trouble maintaining a responsible use of debt. It’s crucial to know that making late payments on a home equity loan puts you in jeopardy of losing your home in foreclosure, which can severely damage your credit and ability to get approved for another mortgage in the future.
Drawbacks To Using Home Equity To Consolidate Debt
Your Home Secures The Loan
The main drawback to using your home’s equity for debt relief is that your home becomes collateral for debts that previously weren’t tied to physical property. Because of this, there’s always some degree of risk that you could lose your home if, for some reason, you can’t repay the loan.
From a risk perspective alone, it’s better not to increase the risk of losing your home simply to pay down credit cards faster. For example, if something happened and you couldn’t pay your credit card debt, there’s no way for the credit card companies to take your home from you.
Paying Interest On Fees
Originating a new mortgage involves numerous professional services to ensure the lender keeps their risk to a minimum. These services include items like appraisals, title searches, and bank origination fees. Combined, these costs of creating a loan can add up to thousands of dollars, with typically higher costs the higher the loan amount is. While these costs can be paid out of pocket by the borrower, most people opt to have these fees rolled into the new loan—especially if it’s a home equity loan.
The downside to this is not only will you be adding to your overall debt load, but that you’ll also end up paying hundreds or even thousands more for these services over the course of the loan because of the interest charges.
Want Debt Relief Without The Risk Of Losing Your Home?
If you’re thinking about a home equity loan for debt consolidation, Alleviate Financial Solutions may have alternatives for you that are less risky.
Whether you need debt consolidation, debt settlement, or help with finding the most intelligent financial course of action, our seasoned team of debt relief experts will help you take the first step to finally becoming debt-free.
Contact the debt relief team at Alleviate Financial Solutions today and discover your options. Call Today!