Using a home equity loan for debt consolidation

2008-05-18T21:29:00.000-07:00

A home equity loan can be a very smart way to clear up credit card debt for two reasons:
1) home equity loans most often have a much lower interest rate than credit cards and other types of non-secured debt.
2) the interest paid on the first $100,000 borrowed is tax deductible where as the interest paid on credit cards is generally not tax deductible. Consult a tax advisor for the specific tax benefits available.

When you take out a home equity loan, you are reducing your equity or ownership in your home. Remember you are borrowing from a portion of your home that you have already paid off so that you can have money to pay off your credit card debt.

While a home equity loan may seem useful in clearing up your debt, there may be situations where a home equity loan may not be good idea for debt consolidation. Say for instance that you had $5,000 in credit card debt. Taking out a home equity loan is not free - in addition to interest there are associated closing costs. It would not be worthwhile to take out a home equity loan and incur closing costs to clear up a small amount of debt.

If however, you have a large amount of debt and the home equity loan interest rate available to you is much lower than your credit cards, a home equity loan makes sense.

Which type of home equity loan is right for you? If you have a huge credit card debt you perhaps lack financial discipline. For this reason, a Standard Home Equity loan and not a Home Equity Line of Credit is more suitable.

A standard home equity loan is a conservative loan choice that has fixed payments and a fixed interest rate. Home equity lines of credit should not be used for debt consolidation since a line of credit gives you the option of making minimum payments on the amount owing - this practice can lead to an unpaid balance at the end of your loan which is a very similar situation to credit card debt.

Home Equity Lines of Credit

2008-05-09T23:34:00.000-07:00

What are Home Equity Lines of Credit?
Home equity lines of credit are revolving credit accounts that are protected by your home. The term revolving credit is often associated with high interest credit cards. However, lines of credit differ from credit cards. Firstly, lines of credit are easier to qualify for. The interest rates are significantly lower than most credit cards, and home equity lines of credit are tax deductible.

Common Uses of a Home Equity Loan
Home equity loans are often obtained for large expenses. These are best used for financing home improvement projects, debt consolidation, paying for a child's college expenses, etc. Additionally, some homeowners obtain home equity lines of credit as a means of having a cash reserve in the event of an emergency.

Pros and Cons of Home Equity Line of Credit
While this home equity option is useful, there are advantages and disadvantages. The benefits surround the ability to payoff high interest credit card debts and other consumer loans.
If using a line of credit for debt consolidation, homeowners will simplify their lives by having a single debt payment, as opposed to several. Furthermore, because of lower rates, homeowners are able to repay a home equity line of credit much sooner.

The disadvantage of home equity lines of credit is that your home serves as collateral for the loan. If for any reason you are unable to repay the loan, the lender may claim your property. This results in losing your home and equity. To avoid foreclosure, borrow a modest amount of money. Also, repay the funds promptly. The problems lies when people think of home equity lines of credit as free money, and begin borrowing and spending frivolously.