Most Americans are inclined to use credit cards and personal loans to fund unsustainable lifestyles. According to https://www.forbes.com, 20% of the respondents of a survey were depending on their credit cards for meeting their basic living expenses and 50% had maxed out at least one card. With credit card rates of interest ranging from 15-25%, living on credit card debts is clearly a horror story. Debt consolidation is a popular strategy for getting on top of personal debt; however, unless you are using a zero-percent balance transfer, which is very limited in its availability, the rate of interest that you could be paying on a debt consolidation loan could still be quite high depending on your credit score. A very effective way of consolidating your credit card and personal loans is using your home equity. The rate of interest in this mode of financing is among the cheapest, which makes the most practical way of getting out of the debt trap. However, since no method is perfect, you need to evaluate the pros and cons of using home equity.
What Is a Home Equity Loan?
Often referred to as a second mortgage, a home equity loan is a method by which you can borrow an additional amount against the equity you already have in your home. If the mortgage has been operating for long, you will have substantial equity in your home and can use this to borrow enough for meeting life’s big expenses or for settling retail loans and credit card balances that carry a very high rate of interest. There is no restriction on the end-use of the home equity loan; you can use it to meet medical expenses, college education, finance home improvements or even pay for a vacation, though that is not recommended. You don’t need to consider refinancing with your current lender, you can take this opportunity to find out the state of the market and take advantage of lower rates from another lender. You could end up saving a lot of money on your first mortgage itself by switching to a lender with a better rate and be able to pay off your home loan faster.
The Advantages of a Home Equity Loan
The first and foremost advantage of a home equity loan is the low rate of interest. This is because the collateral is provided by the home. The very steep rates of interest applicable to credit cards are because the issuer does not have any assurance of repayment except your past financial behavior in the form of a credit score. Another big sense of comfort is that the rate of the interest is fixed for the term of the loan, which means that even if the rates of interest rise, your monthly repayment will not be affected. The fixed nature of the interest rate means that you will always know what the monthly outgo is and how long it will take to repay the loan. Again, this is in sharp contrast to the variable rates of interest of credit cards that can be unilaterally changed by the card issuer at any point in time. You also have the advantage of being able to apply for the exact sum of money that you will require to consolidate your debts using the services of a reputed agency like NationaldebtRelief.com, pay for an emergency, or even a planned expense for which you do not have the ready cash. There are no conditions attached to what you can do with the loan money, and once the approval is through, the money can be used for any purpose that you think fit. The interest that is payable on the home equity loan is tax-deductible even though the proceeds are being used for debt consolidation of credit card dues. Interest paid on cards and personal loans is not tax-deductible.
The Cons of Home Equity Loans
The biggest hazard of using a home equity loan to consolidate your debts is that you are risking your home by offering it as collateral. In effect, you are converting your credit card and personal loans that are unsecured into a secured loan just to take advantage of a lower rate of interest. This means that if you are not disciplined and default on the repayments, you could end up losing your most prized asset and put your family’s security in jeopardy. Compared to a Home Equity Line of Credit or a HELOC, the rate of interest on a home equity loan is higher. This is because of the assurance of a fixed rate throughout the loan. Some of the attractiveness of a home equity loan is reduced because of the need to deal with closing costs and fees that the lender will charge. You may be able to get the amounts included in the loan; however, they remain a cost that has to be factored into the calculations. One of the big dangers of taking a large home equity loan is that in case of a slump in the real estate market, you could find yourself upside down on the loan, i.e. you owe more than what the sale value of the house is. If as a homeowner, you feel that you do not have the financial discipline that is required to successfully repay the home equity loan, you should stay away and explore other options of consolidating your debt that does not put your house at risk.
Conclusion
If you have determined that a home equity loan is the best options for consolidating your debts, you should try to pay back the second mortgage as quickly as possible. Efforts of consolidating debt tend to fail mostly because the tendency to keep on using credit cards irresponsibly does not go away even though the dangers of getting trapped by debt are well known. Even with the interest rate on a home equity loan low, stretching the repayment over 25-30 years means that you will end up paying a lot of interest unnecessarily. It may help to ask your lender to create another account for the home equity loan with its statements and repayment schedule so that you can monitor it effectively and not forget about the extra debt a few months down the line.
