Home equity loan for debt consolidation
Home equity loans give homeowners access to cash based on the amount of equity they have in their home. Homeowners often ask if they can use a home equity loan for debt consolidation. Debt consolidation is a financial strategy that is particularly useful to people who want to consolidate credit card debt when they have several high-interest balances.
Read on to learn more about how to consolidate debt with home equity.
At Credit Union of Southern California (CU SoCal), we make getting a Home Equity Line of Credit (HELOC) easy.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all your banking needs.
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What is a home equity loan?
A
home equity loan lets homeowners borrow money from a lender against the equity in their home. Home equity loans have a fixed interest rate, and you'll accrue interest on the entire amount of the loan you're approved for whether you use the money or not. Home equity loans are different than
home equity lines of credit (HELOCs), which come with a variable interest rate.
How does debt consolidation work?
Debt consolidation refers to taking out a loan or line of credit to pay off other debts or loans. The main goal of debt consolidation is to pay less interest on the new consolidated loan balance, which can save you hundreds of dollars each month. It is recommended that the money saved on interest be put toward paying down the total loan amount until the loan is paid off.
How to use a home equity loan to consolidate debt
Given how easy it is to use and abuse credit cards, many people are finding that they have accumulated too much credit card debt. A debt consolidation home equity loan can be used to consolidate high-interest debts and loans, including credit card debt, student loans, and unpaid medical bills.
It's easy to use a home equity loan for debt consolidation, just follow these steps:
1) Calculate the equity in your home. To
calculate home equity, take the amount your property is currently worth, or the appraised value, and subtract the amount of any existing mortgages on your property.
For example: A home's appraised value is $600,000 – Amount owed on mortgage is $250,000 = $350,000 Equity. Lenders will approve borrowing up to a certain amount of your available equity.
2) Review the eligibility requirements. Each lender has its own requirements which may be posted on the lender's website and available on request. Typical eligibility requirements include sufficient equity,
sufficient income, a good credit score (700 or above), and on-time payment of your current mortgage.
3) Apply for a home equity loan. Apply online or in-person with the lender of your choice.
4) Use funds to pay off debt
. If you are approved for the loan, you will receive a lump sum of money in your account. Next you can consolidate debt using your home equity.
5) Make monthly payments toward your home equity loan. Repaying your home equity loan is like paying your mortgage. You'll make a monthly payment to the lender, which includes repayment toward the loan principal, plus interest on the balance. Home equity loans charge interest on the entire loan amount whether you draw from it or not, whereas home equity lines of credit (HELOCs) only charge interest on the amount of the loan you use.
Advantages of using a home equity loan to consolidate debt
- Streamlined payments. Using one loan to consolidate debt makes payments easy to keep track of and your accounting and record keeping easier to manage.
- Lower interest rate. Credit card companies often charge high interest rates (as much as 20% - 30%) on outstanding balances. Home equity loan interest rates are often significantly less (ranging between 7.5% and 10%), which is why most people save money by consolidating debt to a home equity loan.
- Lower monthly payments. Lower interest rates mean lower monthly payments.
Disadvantages of using a home equity loan to consolidate debt
Consolidating debt to save on interest is generally a good financial move to help get you debt-free, however there are some disadvantages of a debt consolidation home equity loan:
- Home will be used as collateral. Failure to make on-time monthly payments will hurt your credit score. If you default on the loan, the lender can take possession of the home through foreclosure.
- Temptation to keep spending. Having access to a large amount of cash makes it tempting to spend the money on impulse purchases and non-essential items. Staying focused on your financial goals is important so as not to create new debt.
- Fees. Some lenders charge loan fees, such as a monthly or annual maintenance fee just to have the loan account. Prepayment penalty fee may be charged if you close the loan before the end of the loan term or do not use the loan.
What kind of debt should you consolidate with a home equity loan?
When people take out a debt consolidation home equity loan, they benefit most by using the money to pay off the following debts:
- Credit cards. Credit card interest rates a far higher than the interest rate on home equity loans.
- Personal loans. Personal loans may also have higher interest rates than home equity loans
- Medical bills. In an emergency, medical bills can add up quickly, especially if not covered by your health insurance, so a home equity loan can help.
What to avoid consolidating under a home equity loan
Some types of loans and debt are not ideal to consolidate using a home equity loan, because home equity loans often have closing costs and fees, and using your home as collateral to secure the loan could put you at risk of foreclosure. Here are examples of consolidations and expenses to avoid with a home equity loan:
- Auto loans. Auto loan interest rates are generally lower than home equity loan interest rates.
- Vacations. Getting a home equity loan to pay for a vacation increases the cost of the vacation because you'll pay interest on the balance, which could negate any savings you thought you were getting on the vacation price. Vacations are best paid for using a credit card and then paying off the balance as soon as possible.
- Unnecessary expenditures. If you need a loan to pay for luxury purchases, think again. Purchases such as clothing, jewelry, sporting equipment, furniture, and other lower cost items should be avoided, as they will add to your debt load.
Other ways to consolidate debt
As you consider the
pros and cons of home equity loans, here are some additional ways to consolidate debt:
Personal loan. A
personal loan is a type of “unsecured loan” granted to an individual based on their creditworthiness (not collateral) and is given in a lump sum. Repayments are made as fixed amount "installments" based on the loan's fixed interest rate over a fixed period. Monthly payments include paying back the principal balance and interest on the loan. Personal loans can be used for any type of expenses you choose.
Balance transfer credit cards. Most credit card companies offer a promotional 0% APR (annual percentage rate) on balance transfers. The promotional interest rate lasts for a fixed period, usually 12 months, after which the rate increases significantly. Transferring your high-interest debt to one of these cards lets you pay off your debt interest free.
Cash-out refinance. A cash-out refinance is when a homeowner refinances their mortgage to a new mortgage (typically at a lower interest), and in the process, borrows more money than what is needed to pay off the current mortgage. The first mortgage is paid off and the homeowner gets a lump-sum payout of the extra cash amount at closing.
Debt consolidation loan. This is a type of personal loan created to help consumers pay off debt using one easily manageable loan at a lower interest rate. For example, if you have two different credit card balances on which you pay 18% interest and 22% interest, use the debt consolidation loan to pay off both balances, then pay one monthly consolidated loan payment at a lower interest rate. This will save you money each month.
Is using a home equity loan to consolidate debt worth it?
A home equity loan for debt consolidation is only effective if the debt is consolidated into a loan that has a lower interest rate than what you are charged on your current credit cards and loans. A debt consolidation home equity loan may be worth it if you can get a good lower interest rate. Keep in mind that to get a home equity loan your home will be used as collateral and failure to repay the loan, could result in the lender taking possession of your home through a foreclosure.
Why Savvy Consumers Choose CU SoCal
For over 60 years, CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!