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Home Equity Loans For Debt Consolidation

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Consolidate your debt with a home equity loan

Monthly payments on multiple high-interest debts can be demoralizing and expensive. When you pay thousands of dollars of interest each year on credit card debt, private student loans and car payments, you may feel like you will never get out of debt.

Consolidating high-interest debt with a home equity loan can be a good way to reduce monthly payments and eliminate your debt faster. If you own a home and have built up significant equity in it, you could be a good candidate for this type of loan, which you can use to pay off your high-interest debts. That leaves you with one monthly payment, which usually has a lower interest rate than the smaller debts.

What is a home equity loan?

A home equity loan allows homeowners to borrow money and use the equity in their home as collateral. Home equity is calculated by subtracting remaining mortgage payments from the current market value of the home, and homeowners build home equity by making monthly mortgage payments toward the debt’s principal. Home value appreciation also creates home equity.

Know your equity options

With a home equity loan, homeowners can access an amount close to their equity through a lump-sum payment or a home equity line of credit (HELOC), a revolving line of credit that works like a credit card. A home equity loan can be repaid in fixed monthly payments over the life of the loan, while a HELOC requires only that homeowners repay the money they have borrowed on the credit line, with interest.

How To Calculate Home Equity
Home Appraisal
Mortgage Balance
Equity
House 1
$300,000
$190,000
$110,000
House 2
$325,000
$190,000
$135,000

Pros of a home equity loan

  • Less interest
  • Predictable payments
  • Tax deduction

Cons of a home equity loan

  • Foreclosure risk
  • Fees and costs
  • Deepening debt
  • Too much cash on hand

Benefits of a home equity loan


Less interest: The primary benefit of using home equity loans for debt consolidation is that you will make one loan payment a month rather than numerous smaller payments. Along with simplifying your budget, a home equity loan typically comes with a lower interest rate than personal loans and credit cards and can significantly reduce the amount of interest paid over the life of your debts.

Interest rates will be lower because your home serves as collateral, making it a secured loan and one of the cheapest ways to borrow money.

Predictable payments: Home equity loans are predictable because payments and interest rates are fixed. You will pay the same amount each month toward a single loan, making it easy to budget and plan for.

Tax deduction: The interest on the first $100,000 a homeowner borrows with a home equity loan used to consolidate debt may be tax deductible. If you plan to claim this deduction, consult a tax professional first, as filing mistakes can be expensive and tax laws change regularly.
Interest can be deducted on home equity loans for primary and secondary homes. For homeowners who rent out their second home and want to claim this deduction, the IRS restricts them to using the property to 14 days annually or 10 percent of the time the second home is rented at a fair-market value, whichever is longer.

Downsides of a home equity loan


Foreclosure risk: The most important factor in considering whether to apply for a home equity loan is the lender can foreclose your house if you don’t make your monthly loan payments. Before signing for the loan, make sure that you are in a financial position to always meet monthly payments.

Fees and costs: Lenders will charge closing costs and fees when taking out a home equity loan. Closing costs can be between 2 and 5 percent of the amount of the loan, and fees can include application fees, document preparation, a title search and an appraisal. The loan may also come with a maintenance fee. Be sure to compare costs and fees among several lenders before choosing one for your loan.

Deepening debt: While a home equity loan used to consolidate debt can lower monthly payments, it still deepens a homeowner’s overall debt. Paying down a mortgage or owning a house until the market value significantly increases can take years, and borrowing that equity erases that work and puts the homeowner further into debt. Homeowners should carefully consider whether a home equity loan is the best choice for paying down other debt.

Too much cash on hand: It can be tempting to spend home equity loans, which provide a large sum of cash at once, on expenses other than paying off debt. Homeowners should resist the urge to spend the money on vacations, shopping or other splurges and instead stay focused on paying off all debt, including the home equity loan.

Will I qualify?

Because these loans are secured by the equity in borrowers’ homes, homeowners may more easily qualify for them than an unsecured loan, like a personal loan. This means that homeowners who don’t have a great credit score could still qualify.

Lenders will look at four key aspects of your finances when determining whether to approve you for a home equity loan.

1

Equity

Do you have significant equity in your home? Many lenders require that the applicant maintain at least 20 percent equity in their home after the home equity loan has closed. That means for a $150,000 house, the homeowner should owe no more than $120,000, including the home equity loan.This requirement reduces the risk for lenders, assuring them that the homeowner will retain equity in their home even if the home’s market value drops.

2

Credit

Because the home’s value serves as collateral for a home equity loan, lenders will often be more lenient with credit scores. Applicants with good credit scores may get the best loan terms, but lenders often will work with homeowners who have less-than-stellar credit as well as significant home equity and a stable work history. If you’re wondering where your credit stands now, you can get a free credit score right here on LendingTree.

3

Ability to repay

Applicants must demonstrate to lenders that they have the means to repay the loan and make monthly payments. That means having a steady job or income stream, as well as a history of consistent employment and good management of monthly financial obligations.

4

Low debt-to-income (DTI) ratio

Lenders are more apt to approve borrowers whose income significantly exceeds their debt. Lenders typically require a debt-to-income ratio lower than 43 percent, meaning your monthly debt obligations, including your expected home equity loan payment, make up less than 43 percent of your monthly pre-tax income. Lenders will look at credit card bills, child support, student loans, car payments, mortgage payments, homeowners insurance, taxes, and other financial obligations to determine your DTI.

Other things to consider

Loan borrowing limit: The maximum amount of a home equity loan will vary by lender and will depend on a homeowner’s credit, home market value, and income. However, homeowners shouldn’t expect to receive a home equity loan for more than 85 percent of the equity in their home.

Does my home have equity? Here’s how lenders figure out the amount of home equity that determines how much you can borrow against, using an example of a home with a fair market value of $250,000 with a mortgage balance of $150,000:

Multiply the home’s current fair-market value by a loan-to-value ratio of 80 percent:

$250,000 x .80 = $200,000

Then subtract the current mortgage balance from that number:

$200,000 – $150,000 = $50,000

That means you can borrow against your current equity of $50,000.

Homeowners also can use a home equity calculator to determine the equity in their home that they can borrow against.

Frequently Asked Questions

Should I use a home equity loan for debt consolidation?

Borrowing against a home equity loan is a big step, as it can erase debt a homeowner has spent years paying off and risk foreclosure if the homeowner defaults on the loan. However, for homeowners who have stable work, can control their spending, and are committed to paying off debt, a home equity loan can be an excellent way to reduce debt faster.

Can I lose my home doing this?

Yes. Because home equity loans require that borrowers put up their home equity as collateral, defaulting on the loan would result in the bank seizing the house. Home equity loans can be an excellent option for homeowners who are confident that they can make the monthly payments on the loan, but homeowners who aren’t sure about their job stability and ability to make loan payments may want to weigh carefully the benefits of a home equity loan to consolidate debt over the risk of losing their home.

How much money can I save?

To calculate savings, homeowners should compare their current debt, interest payments, and length of the loans to the terms of a home equity loan. Even if a home equity loan will require a much longer payment period, the savings in interest payments could make it worthwhile.

Debt relief calculators can help you determine how much you can save with a home equity loan.

Are interest rates favorable?

Interest rates remain at long-time lows, making now an ideal time to apply for a home equity loan.

How do I choose the best home equity loan?

Before applying, homeowners should shop around different lenders and ask about rates and terms for home equity loans. Talk to banks, credit unions and mortgage companies and compare their loan plans. Some lenders will negotiate some fees, and you can ask one lender to offer fees comparable to another. After you get quotes for multiple loans, look at interest rates, repayment terms, fees and closing costs to choose the one that suits you best.

What are alternative options?

Here are a few other ways to pay off high-interest debt:

HELOC: A home equity line of credit (HELOC) is an alternative to a home equity loan that works like a credit card. Instead of receiving the loan in a lump sum, borrowers with a HELOC withdraw only as much money as they need at the time. In return, the homeowner only makes monthly payments and interest on the money withdrawn so far, not on the entire amount of the line of credit. Money can be withdrawn through debit cards or checks.
HELOCs typically have more repayment flexibility than home equity loans. Some HELOCs allow interest-only payments for a specified period, but when the repayment period ends, the borrower is expected to fully repay the balance due on the line of credit.

Like home equity loans, HELOCs may require fees or closing costs. And they generally carry variable interest rates, which make payment amounts less predictable.

Personal loans: If you have a good credit score, you may qualify for a personal loan that has a lower interest rate than your current debts. Rates can be as low as 5 or 6 percent for borrowers with good credit. Personal loans and other unsecured credit options may be a good option for anyone turned off by a home equity loan or HELOC because of the possibility of losing their home.
There are also secured personal loans, which will have lower interest rates than unsecured personal loans, which require collateral. Borrowers can use a car or other valuable items as collateral rather than their house.

Balance transfers: If you have a credit score greater than 700, you may be eligible to transfer your balance from a high-interest credit card to one with a an introductory 0% interest rate for a specified time. Some credit cards will allow you to transfer a balance with no fees and allow payments without interest for as many as 15 to 24 months, which can buy you time to pay down the balance without paying interest.

Debt avalanche strategy: If you decide not to take out a loan, rearranging your budget can help you speed up your debt repayment. The debt avalanche strategy involves putting as many resources as possible toward your highest-interest debt, and when that is paid off, apply those resources to the next-highest-interest debt, and so on.
A key to paying off any kind of debt is understanding why you have debt and exercising self-discipline while you pay off the existing debt. That may mean cutting back on spending, forgoing vacations, or taking on another job while you focus your resources on paying down debt. Getting out of debt can be worth the work as you rein in spending, stick to a budget, and reap the emotional and financial rewards of paying off what may have seemed like insurmountable debt.