Home equity loans have relatively low interest rates, especially when compared to unsecured debt like credit cards. If you are one of the millions of Americans who are burdened with consumer debt, taking out a home equity loan to pay off high-interest debt can be a very attractive option.
Main recipients
- Consolidating high-interest debt from credit cards or personal loans into a lower-interest home equity loan can help you pay off your debt faster and with less money overall.
- If you fail to repay your home equity loan, you could lose your home during foreclosure.
- If the value of your home is less than the balance of your mortgage and mortgage loan, you may not be able to sell or move your home.
- Be sure to address the root cause of your high-interest debt so you don’t get stuck in a cycle of home equity loan debt.
Pros and Cons of Using a Home Equity Loan to Pay Off Debt
Advantage
The interest rates on home equity loans are much lower than those on many other types of debt. If you can only afford to pay a certain amount of debt each month, taking out a home equity loan to pay it off can help you pay it off faster. A lower interest rate means a higher portion of your monthly payment will go toward paying down principal. From a financial perspective, paying off high-interest debt with a low-interest home equity loan will save you the most money in the long run.
shortcoming
There are many disadvantages to paying off a home equity loan that should not be ignored. Even if you consider using a home equity loan to pay off your debt, you may find yourself dipping into funds for no reason, causing your debt to increase further. If you use a home equity loan to pay off your debt and default on your mortgage, you could lose your home to foreclosure. While defaulting on unsecured debt can harm your credit for years, defaulting on a home equity loan can damage your credit and leave you homeless.
Even if you use your mortgage responsibly and make your monthly payments, you may find yourself with less than the amount you owe if the value of your home drops. In this case, you won’t be able to move or sell your home for years until you pay off your mortgage or the value of your home increases.
Behavioral changes
While consolidating high-interest debt into a lower-interest home equity loan may be the smartest move from a financial perspective, don’t ignore the emotional and behavioral risks. “Consolidating high-interest debt into a home equity loan can be a great money-saving strategy, but it will only work if you address the root cause of the debt,” says Daniel Yerger, Certified Financial Planner and owner of MY Wealth Planners. He says.
If you have high consumer debt and are using a home equity loan to pay it off, be sure to address the factors that led to your high debt balance so you don’t end up in the same situation you were in a few months or years ago. Consider downloading a budgeting app to track your spending and make sure you’re spending money on things you really care about. Be sure to put savings into an emergency fund so that when things go wrong, you’re not stuck with debt on high-interest credit cards.
What is Debt Consolidation?
Debt consolidation is when you take out new loans to pay off other loans. Taking out a home equity loan to pay off old debt is a form of debt consolidation.
Do I need good credit to get a home equity loan?
While each lender’s requirements vary, getting a home equity loan requires good credit. Home equity loans use the equity in your home as collateral, so you may be approved for a home equity loan even if you wouldn’t qualify for an unsecured personal loan.
Can I get approved for a home equity loan if I have a lot of credit card debt?
Yes, you can get a home equity loan for most credit card debts, as long as you have enough income and enough equity in your home. Lenders consider many factors when applying for a home loan, such as:
- A loan-to-value ratio (CLTV) of 85% or less is usually required. This means your mortgage balance and home loan balance divided by the home’s value is less than 85%.
- Consider your debt-to-income ratio (DTI). Your DTI ratio is your total monthly debt payments divided by your gross monthly income. Most lenders prefer your DTI ratio to be 36% or lower.
in conclusion
Consolidating high-interest debt into a low-interest home equity loan can help you pay off your debt faster and cheaper. Before applying for a home equity loan, be sure to understand the risks and set yourself up for future success by developing good financial habits first.
