Using a home equity loan can be an attractive debt consolidation option for many homeowners, but it is not an instant cure. It is a common misconception that everything will be fine if you can just payoff those credit cards. Always remember that consolidation is nothing more than transferring the debt.
Don't allow yourself to be fooled into feeling the debt is gone. Once you obtain your loan, close some of your credit cards or reduce your credit limits so that you do not get yourself deep in debt again. Too many people charge their cards back up after consolidating their debt, and then they're in worse shape than they were to begin with.
Many financial experts are concerned about using equity to payoff debts, and rightly so. Below are some pros and cons for using the equity in your home.
Pros:
- Many equity loans will offer a lower interest rate compared to what you're paying on your credit cards. The difference in rates can help toward reducing your monthly payments.
- Depending on your tax situation, the interest accrued on a home equity loan may be tax deductible. This can add further savings and help reduce the time in paying off the debt.
- The longer repayment periods offered with a home equity loan can also reduce your monthly payment, freeing up your monthly cash flow. This can be good or bad so I've added this to the Cons as well.
Cons:
- When you take out a home equity loan you're putting your home up as a guarantee that the debt will be repaid. If you fail to make your payments, the bank may foreclose on the property. If you are stretched too thin and cannot make the payments you have now, do not use an equity loan.
- The longer term may help to lower your payment, but you will pay much more in interest over the term of the loan. If you bought something because it was a really great deal, those savings may be eaten up by interest.
- If the value of your home drops, you may owe more on your home than what it is worth. The bank could then ask you to pay the full amount of the loan right away. For this reason, you do not want to use all of the equity in your home.
Loan Shopping
When shopping, you will find many lenders offering the choice of a home equity loan or a home equity line of credit. When your purpose is to consolidate debt, stay away from the equity line of credit. The lenders will be looking at how much credit limit you have now. If you're already in trouble, adding another line of credit will not help you get approved.
Look for no closing cost offers. Some lenders will waive the closing costs if you hold the loan with them for 2 or 3 years.
Rate discounts can also be available if you open an account with the lender or choose auto debit payments.
Also, watch out for pre-payment penalties and hidden fees. Ask lots of questions and examine all the fine print. If you know anyone that has obtained an equity loan, recruit their help.
