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Home Equity Loan for Debt Consolidation

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Debt consolidation is a smart proposition for anyone with multiple loans or credit cards that each demand their own monthly payments. A consolidation loan at a reasonable rate can save you thousands of dollars in interest, making it easier to pay off debts and get your finances back in order. The best interest rates on debt consolidation loans are on secured loans, making home equity loans a popular choice for debt consolidation.

How Does a Home Equity Loan Work?

Home equity loans are secured loans that use the equity you have accrued in your home (or another property) as collateral. By using your home as security on the loan, you can get lower interest rates and more flexible payment options. Depending on how much equity you built up, it's possible to get a loan for as much as 80-90% of the value you own in your home. This percentage is referred to as the loan-to-value ratio, or LTV for short.

Home equity loans can be one-time installment loans or they can be lines of credit. What's the difference?

  • An installment loan refers to a one-time withdrawal of money that is scheduled to be paid back in installments. Each installment payment includes both principal and interest
  • A line of credit is a set loan amount that you can draw against as necessary, similar to a checking account. Most credit line products have features in which monthly payments early in the contract require paying only the interest; the principal is payable at a later specified date, usually 3-5 years after the line of credit is arranged

In both cases, the loan is secured against the value of your property, so you do run the risk of losing your home if you cannot pay back the loan as arranged.

Consolidating Your Debt With a Home Equity Loan

Home equity loans are a simple way to combine all of your debts so you can pay them back with one convenient monthly payment. You'll also save considerably on interest: credit card interest rates are typically 18-20%, but home equity loans can have much lower rates.

It's possible to pay off all of your existing loans by taking out a home equity installment loan for the total amount. Alternately, you can use a home equity line of credit to pay off just a portion of your debts and defer paying back the total amount until your financial situation has improved.

Risks of Debt Consolidation in Home Equity Loans

The main danger of consolidating debt in a home equity loan is that your house is at risk if you become unable to pay back the loan. A bank or lender has the right to seize your home and sell it should you default on your debt.

If you're considering using your equity to pay off bills but aren't sure if or when you'll be able to pay the debt back, a home equity loan may not be the best choice. It might seem like easy money, but it can have some serious consequences.

When Does Taking Out a Home Equity Loan for Debt Consolidation Make Sense?

Despite the risks, a home equity loan does make sense for debt consolidation if you're sure that you will be able to repay the amount of the loan as you've agreed. A home equity debt consolidation is a good idea if you have enough income to pay several high interest debts but you'd rather save money by rolling them into a lower-interest loan.

If you're a skilled professional currently between jobs, a home equity line of credit might be a smart choice - but a home equity installment loan may put you in greater financial danger when the first installment payment comes due in a month. Plan ahead and consider how and when you'll realistically be able to pay back the loan. Also keep in mind that it may be difficult to get a home equity loan in the present economic climate, depending on your job status and financial health.