Using a Home Equity Loan to Consolidate Bills

For most people in their late 20s and 30s, debt is a huge menace. And this debt could be coming from different directions as well. Credit card debt, student loans, and car payments combine to demoralize you and to help spell out the notion that your debt woes are here to stay forever. 

Debt is the biggest reason why many people have no savings. Of course, no one wants to be debt-ridden, so it seems wiser to pay off loans first rather than save for retirement. 

Debt is also the reason why many people choose to work post retirement. Paying off loans turns out to be more expensive than what most people tend to think, and the years don't pass soon enough.

There's a smart option to consolidate all your bills into one monthly payment, and that's by using a home equity loan. If you own a house and have considerable equity built up in it, you could be eligible for a home equity loan, which is often used to pay off high-interest debts.

A home equity loan usually has a lower interest rate than other types of loans, helping you get out of debt faster.

What is a home equity loan?

If you are homeowner, a home equity loan will allow you to borrow money and use the equity in your property as collateral. Home equity is calculated by taking the current market value of the house and subtracting the remaining mortgage payments from it. 

You can build home equity by making monthly mortgage payments towards the home loan. Appreciation of the property's market value also creates equity.

When you take a home equity loan, you are lent an amount close to your equity, usually through a one-time lump-sum payment or a home equity line of credit (HELOC), which works like a credit card. 

A home equity loan is usually paid off in fixed monthly amounts like a regular loan, whereas a HELOC requires you to pay off the borrowed money on the credit line with interest.

Pros and cons of a home equity loan

While home equity loans have become quite popular in recent times for a number of reasons, there are also a few downsides to it.

Advantages of a home equity loan

Lower interest rate: The most important benefit of debt consolidation with home equity loans is the lower interest rate. You pay only one debt, instead of multiple smaller loans. This reduces the amount of interest paid over the life of the debt. Since your house serves as collateral, home equity is a secured and one of the cheapest loans.

Fixed payments: Another benefit of home equity loans is the fixed rate. As a result, the payments are predictable. You have to pay the same amount each month, making it easy to manage the budget and payments. Well easy as long as your name is not Napoleon Dynamite but that is another story! 

Tax deduction: The interest on the first $100,000 a homeowner borrows with a home equity loan may be tax deductible. If you plan to claim this tax deduction, first consult a tax professional, because tax laws change frequently and filing mistakes can be expensive.

Disadvantages of a home equity loan

Risk of foreclosure: The biggest disadvantage of a home equity loan is the risk of foreclosure by the lender. Since the house serves as collateral, it can be foreclosed by the lender if you don't make your payments on time. In order to avoid losing your home, make sure you are financially stable before signing up for a home equity loan.

Fees: Always be sure that lenders will charge high fees when taking out a home equity loan. While closing costs are anywhere between two and five percent of the total amount of the loan, there are additional fees like application fees, document preparation, a title search, and an appraisal. 

Sometimes, the loan also comes with a maintenance fee. Always do proper research or talk to an expert before taking out a loan. If this expert is Alan Harper from Two in a Half Men then you need to speak to someone else! 

Higher debt: It's true that a home equity loan is used to consolidate debt because it results in lower payments and interest rates. But it's also true that paying off a mortgage or having the market value of the home rise can take years, and the home equity loan is still a debt that needs to be paid off. 

Therefore, before taking out a home equity loan, home owners must carefully consider if that is the best choice for consolidating their debt.

Lump sum cash on hand: The home equity loan is provided typically we a lump sum amount, and it can be tempting to spend the money on other things. However, to be able to avoid a foreclosure, that money must only be used to pay off debt, instead of splurging on other pleasures.

Who is eligible?

There are a few factors that make you eligible for a home equity loan. First and foremost, you have to own a home and also have significant equity built on it. For instance, if the market value of your house is $150,000, your debt should be no more than $120000, including the home equity loan. 

You must also have a good credit score, although this is not mandatory. Since this is a secured loan, with your home serving as the collateral, you may still be eligible for the loan even with an average credit score. But having a stellar credit score increases your chances of approval.

You must also be able to prove your financial stability. To be approved for the loan, you must be able to convince lenders that you have the means to pay off the loan. This includes a steady job or income stream, with a consistent history of timely debt repayments. 

You must also have a debt to income ratio of less than 43 percent to be eligible for the loan. Lenders will look at credit card bills, student loans, child support, mortgage payments, car payments, insurance, taxes, and other factors to calculate your DTI.

Is a home equity loan the right choice for consolidating debt?

A home equity loan is a big step, and it undoes the debt that a homeowner has spent years paying off. However, if you have a stable income, your spending habits are under control, and the commitment and discipline required to pay off debt, a home equity loan is often an excellent way to pay off debt faster.