Pros And Cons Of Debt Consolidation – Owning a home is a process. Most home buyers don’t pay cash for their homes, so they have to take out a mortgage and make payments for several years before they can say they own it outright. Each of those payments helps build equity, which is the percentage of the home’s total value that the buyer controls. That equity is an asset.
A home equity loan is a secured loan whose collateral is the equity the home buyer has built up over time. Home equity loans are often taken out to make home improvements or to get through difficult financial situations. They can also be used for debt consolidation. In this article, we will explain how it works and why it is good.
Pros And Cons Of Debt Consolidation
Consolidation of debt means lowering interest rates. Credit card interest rates are high. Home equity loan interest rates are generally lower because they are safer loans than other loan products and the interest payments are tax deductible. This makes this type of loan a good option for consolidating high-interest credit card debt and streamlining expenses.
Complete Guide To The Pros And Cons Of Debt Consolidation
There are definitely benefits, but it’s also important to understand the risks. Borrowing against your home puts the home into foreclosure if you fail to make the payments. Any attempt to take out a home equity loan requires careful financial planning. An unsecured personal loan is a good option even if the interest rates are high.
Another risk with home equity loans is that property values can decline over the life of the loan. This can result in the homeowner being “upside down” and paying more than the home is worth. Repayment terms for home equity loans can be ten years or more, so property values are likely to change. Look at market projections before you act to see if they are likely to go up.
Interest rates on home equity loans are much lower than other types of loans such as credit cards. This is because home equity loans are secured loans, meaning you are providing collateral to the lender.
Home equity loans typically have longer repayment periods than other types of loans, so your monthly payments can be lower.
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Instead of worrying about due dates and payments for multiple bills, you only have to worry about paying one per month.
If you use your loan to improve the value of your home, such as building an addition or renovating a kitchen, your interest is tax deductible. The loan is not deductible for anything used.
Because you’re offering your home as collateral to the lender, you pose less risk to the lender and usually don’t need a super high credit score to qualify. However, higher scores usually allow for better interest rates.
Your home is used as collateral for the loan. If you miss payments, your home could go into foreclosure.
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If your home’s value drops and you suddenly owe more than your home’s value, you can foreclose on your property to the bank.
It can take 30 days or more to get the paperwork for your home equity loan, so if you’re in a rush to consolidate, this might not be the best option for you.
One major downside of a home equity loan is that you are simply adding to your debt load. If you’re already overloaded and unable to meet payments, adding additional debt can wreak havoc on your finances.
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Pros And Cons Of Debt Consolidation
You can only get a home equity loan if you have equity in your loan, although in some cases, you can get a home equity loan right after buying your home. How much you can borrow depends on the lender and the type of loan, as well as how much equity you qualify for. Typically, you should have at least 15% to 20% equity in your home.
Additionally, lenders want borrowers to have good credit (at least 660, though 700 or higher is preferred), a low debt-to-income ratio (less than 43%), sufficient income and a reliable payment history on your credit report.
As requirements vary by lender, check with your specific lender for more information and to see if you qualify.
The requirements to qualify for a home equity loan vary from provider to provider, but here are some common points they can look for:
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Home equity loans are available from most banks, credit unions, online lenders and mortgage brokers. Usually the institution that held your original mortgage is the best place to apply, but you should check interest rates elsewhere before you do. Your credit score may have improved since you bought your home, so better deals may be available.
When evaluating a personal loan versus a home equity loan for debt consolidation, consider the risks involved. Home equity loans offer lower interest rates because they are secured, but it is your home. Do you want to risk it to pay off your credit cards? Personal loans are unsecured, so your consequence for default is collections, not foreclosure.
The average interest rate on personal loans is just under 10%. The average credit card interest rate in the United States is over 19%. That means using a personal loan for debt consolidation can save you a significant amount of money without risking your home. Do the math on home equity loans, but it’s wise to consider a personal loan as an alternative.
Home equity loans are essentially a second mortgage on your home. You get the money in one lump sum payment and you can use it for whatever you like. Obviously, in this case, it is debt consolidation. Here are the advantages of doing so:
What Is Debt Consolidation, And Should I Consolidate?
As explained, a HELOC is a home equity loan. It differs from a home equity loan as the borrower does not take a fixed amount. They can borrow up to the approved limit. HELOCs come with variable interest rates, not fixed rates like home equity loans. This is another option for debt consolidation, which you should discuss with your lender.
There are four key differences between home equity loans and HELOCs that you should know when deciding which is best for you.
Home equity loans pay off in one lump sum, while a HELOC allows you to withdraw money as needed.
Home equity loans charge a fixed rate of interest, so you have a clear and specific repayment schedule. HELOCs charge variable interest rates, so the rates are based on a standard index (meaning they are subject to change based on the US economy).
The Pros And Cons Of Debt Consolidation
Home equity loans have no annual fees, but some HELOCs have transaction fees and annual fees during the repayment period.
Since home equity loans come in lump sums, you pay interest on everything, even if you don’t use the full amount. With HELOCs, you only pay interest on the money you actually need.
There are several alternatives to home equity loans for debt consolidation. We have already talked about personal loans. You will pay them a little more interest, but you don’t need to put your home at risk. Other options to look at include the following:
1. Personal Loan: Personal loan funds can be used for anything including debt consolidation. If you can get a personal loan with a lower interest rate than your current debt, you can use the money to pay off your high-interest debt and then make just one down payment on the new loan. This will help you pay off your loan faster and save you money on interest.
The Pros And Cons Of Credit Card Debt Consolidation
2. Balance Transfer Credit Cards: Credit card companies sometimes offer a 0% interest introductory period for balance transfers. This is an option for debt consolidation if you have a few accounts and the balance is small.
3. Cash-out Refinance: A cash-out refinance is similar to a home equity loan, but the borrower takes out a larger loan to pay off the existing mortgage balance and the required loan consolidation funds. Lenders prefer this because it involves less risk for them and does not create a second mortgage for the home owner.
4. 401(k) Loans: If you have an employer-sponsored 401(k) plan, you can take out a loan from it to consolidate your credit card debt. It’s your money, so you’re borrowing from yourself, but it’s also your retirement nest egg, so pay it back as soon as possible if you choose this option.
5. Debt Management Plan: a