Sometimes, it is a good idea to have all your eggs in one basket.
Consolidating debt can simplify your repayments and save you money over the long-term. However, if you are using your home as collateral for your existing debt through a home equity line of credit (HELOC), you need to be aware that failure to repay could result in you losing your home.
How to consolidate debt using your home’s equity
You may be facing multiple monthly payments for things such as your mortgage, student loans, or credit cards.
Jeffrey Arevalo, a financial expert at GreenPath Financial Wellness, says that most consumers have some form of unsecured debt. COVID has made it even more difficult to manage.
You consolidate your debt by taking out one large loan that you can use to pay off all your existing debt. This will allow you to only pay one monthly loan payment, and ideally, it will have a lower interest rate than your other loans.
If your credit card is charging 16% interest on your credit card debt and you consolidate the loan into a home equity credit line with a rate of around 5%, you can save a lot of money on interest.
Arevalo states that debt consolidation is a good option for anyone who is struggling to pay off their debts.
If you have enough equity in your home, a home loan or home equity credit (HELOC), may be a good option. A home equity loan works in the same way as a traditional loan. You will receive a lump sum at your first term and then you will be paying monthly (plus interest) until the loan is paid off. A home equity credit line is similar to a credit card. You can choose how much you spend on it as you wish, and you have a repayment period to repay the loan (plus interest).
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Does it make sense to use your home equity to consolidate debt?
Before consolidating your debt, you should carefully consider your repayment plans and whether the underlying behavior that caused your debt are going to continue.
Arevalo states, “You need to be careful about turning unsecured credit into secured debt.” You could be in foreclosure if you default on your home equity loan or line of credit.
You could lose your home if your payments are not made on time.
“It’s dangerous to borrow money from your home to pay your credit cards. It’s because we often don’t make changes in our lives. Craig Lemoine, director of the Academy for Home Equity in Financial Planning (University of Illinois), says that we end up putting all of the debts into one big pile.
If you do it right and make timely payments, it can help you save money on debt repayments.
Consolidating high-interest loans into a HELOC, or home equity loan, can “potentially save you thousands of dollars a monthly,” says Darren Q. English (Quontic’s development loan officer).
You must address the root causes of your debt.
Arevalo states that if they find they can save more on interest and are willing to convert unsecured debt into secured, then a home equity loan might make sense. However, it is important to address any behavior or circumstances that contributed to the debt accumulation in the first instance.
Home Equity Loan vs. HELOC Debt Consolidation
You can use either product to consolidate debt. First, you will take out your HELOC loan or home equity loan. Then, you’ll pay off existing debt. After that, there will be only one loan.
A home equity loan is a traditional, more structured loan. Arevalo says that a home equity loan is a lump sum secured against your house. Most consumers can use it to pay off their debts “fairly quickly.”
A home equity loan will have a fixed interest rate. This means that your interest rate will not change and you will lock it in at the start of your loan term.
Other options for debt consolidation
You can reach out to a counseling agency for free if you are considering debt consolidation but are unsure if it is right for you.
A balance transfer credit card is a good option if you don’t want to make your unsecured debt secure. A personal loan may be an option depending on the amount of debt you have to pay. Each option has its pros and cons so make sure you do your research before making a decision.
Arevalo warns that no matter what you do, you should “be sure you aren’t just moving your debt around to other places instead of actually dealing with it head on.”