Credit card debt. Student loans. Mortgages. Personal loans. Retail debt. Medical bills. If your various forms of debt with high interest rates are starting to feel overwhelming, you may be wishing there was a way to condense them into one easy-to-pay, low-interest loan.
If you’re a homeowner with equity in your house, you have the opportunity to do just that via a fixed-rate home equity loan. Any loan taken out against your home has potential consequences, which is why it’s important to weigh the pros and cons and assess whether a home equity loan for debt consolidation is right for you. In this article, we’ll break down some of the most important advantages and disadvantages to keep in mind.
Pros of Consolidating Debt with a Home Equity Loan
A home equity loan can be a great tool for debt management. Here are some reasons why.
1. Home equity loans offer much better interest rates than other loans and credit cards.
Low interest rates make home equity loans a great product for repaying more expensive debt. Though you’ll have the same principal balance to pay, the difference between interest payments with a 4% APR home equity loan and a 20% APR credit card can be substantial.
2. Home equity loans are easier to secure than other types of loans.
With a home equity loan, your home serves as collateral and helps guarantee loan repayment. Because of this, they are often easier to qualify for than unsecured loans. This can be especially helpful if your credit score has taken a hit due to your mounting debt.
Though easy approval is an advantage, letting your home serve as collateral can also lead to one of the most dangerous pitfalls of home equity loans, which we’ll discuss in the second half of this article.
3. It can boost your credit score.
You may initially experience a small dip in your credit score because you’ve taken out a new credit account, but debt consolidation will help improve your credit score over time.
A big factor in determining your credit score is your credit utilization ratio. So if you’ve maxed out or are close to reaching your limit on your credit cards, taking out a new loan and paying those down can lower your credit utilization and improve your score.
Similarly, improving your payment history will boost your score. This won’t happen overnight, but if you use your debt consolidation to make positive financial changes, there will be an improvement.
4. You will only have one monthly payment to worry about.
Juggling multiple debt bills each month can feel overwhelming. Sometimes having everything wrapped up in one simple bill allows you to take control and make sure it gets paid every month.
Disadvantages of Using a Home Equity Loan to Consolidate Debt
A home equity loan isn’t always the answer to your debt woes. Here’s why you should be cautious.
1. You could face foreclosure if you default.
This is the number one reason why you should be careful when taking out a home equity loan for debt consolidation. If you fail to repay the loan, your lender will be able to foreclose on your house, meaning you will be left without a roof over your head.
You must have a solid repayment plan going into a home equity loan. If you don’t believe you have the means to repay your new loan, debt consolidation is not worth losing your home.
2. It is still debt.
Yes, a home equity loan can be helpful, but it’s important to remember that it is still debt. Taking on more debt will do no good if you don’t make the necessary changes in your spending habits to pay it off diligently.
3. If you’re almost finished paying off a debt, you may end up paying more interest on it if it’s incorporated into a longer-term home equity loan.
Be sure to do the math before consolidating debt. Even if you get a better interest rate, it may not pay off in the long term if you stretch the payments (and interest accrual) out over a longer period of time.
Similarly, you’ll want to make sure that you are saving more than what you spend on closing costs and other fees associated with taking out the loan.
4. Incorporating private or federal education loans into a home equity loan may not be worthwhile, as they tend to come with valuable tax benefits.
Home equity loans have tax benefits— only if you use the funds to buy, build, or substantially improve the home that secures the loan. However, other types of loans like federal education loans come with benefits like tax-deductible interest payments. You’ll want to be sure to consult a tax professional before refinancing them to see if you’ll really save money overall.
Other Debt Management and Consolidation Options
A home equity loan isn’t your only option for managing or consolidating your debt. You have other options, including:
- A balance transfer credit card: With a credit card balance transfer, you will move your outstanding balance(s) from one card to another with more favorable terms. These often come with low-interest introductory offers that give you time to pay down your balance without racking up more interest charges.
- A personal loan: An unsecured personal loan can give some of the same benefits of a home equity loan without having your home tied to it as collateral.
- Debt repayment plan: Instead of taking out a loan or credit card to consolidate, you can sit down and formulate a detailed plan to repay the outstanding debts you have.
Like a home equity loan, it’s important to not abuse any additional funds or credit that you are extended. It is only beneficial if you pay it off on time.
Using Your Home Equity Loan Wisely
A home equity loan for debt consolidation can help solve your financial problems only if you make the lifestyle changes necessary to keep you from accruing additional debt. Be sure to compare lenders’ rates, fees, and loan intervals before making a decision, and be realistic about the payment you can make each month over the life of the loan. Even though it may seem like the perfect solution, not repaying a home equity loan can come with serious consequences, so it’s important to weigh your options carefully.