Home Equity Loan To Pay Off Debt? 3 Things To Consider
As you are determining your best options for paying off your debt, taking out a home equity loan or home equity line of credit to pay off your creditors is an option to consider. Using your home's value to consolidate debt has pluses and minuses.
The rough housing market - and declining home values - had removed equity loans as an option for many. But a rebound in many U.S. markets means consumers can once again consider the equity option.
"The good news is that the financial outlook is now much better than it has been for some time with many economists predicting a turnaround in the housing market in the new future," says Don McClintic, senior vice president of home equity and direct lending at SunTrust Bank. "Consumers are now more confident that their home values will increase and that confidence will most likely lead to more people considering taking home equity loans out to pay off debt."
Before shifting your consumer debt from credit cards and banks to a home equity loan, you should carefully consider the benefits and risks of this financial move.
2-Benefits of Paying Off Debt with Home Equity Loan
One of the main pluses is the psychological benefit of only having one loan and one creditor. "Consolidation simplifies your life because instead of five loans you have one loan," says Thomas Corely, president of the accounting and financial planning firm Cerefice & Company. If you have a habit of paying bills late, you may also save money on late fees by reducing the bills you have to keep track of. Additionally, many people feel that psychological burden from their debt is lifted because they don't view a home equity loan as debt, even though in reality it is.
There are also financial benefits to shifting your debt to a home equity loan. "Home equity loans typically have a lower interest rate than other forms of credit, such as credit cards," McClintic says. If you are unable to pay all of your current credit bills, you may also find that shifting your debt to a home equity loan will allow you to meet your financial obligations each month. Most people can reduce the amount they must pay creditors each month by consolidating their debt to home equity loan because they can take out a 20 to 30 year loan, says McClintic. "However, if you goal is to pay off your debts and live debt free, then the downside of the reduced payments is that taking out a home equity loan can mean that you will not be out of debt for a long time."
3-Risks of Using the Home Equity Loan for Debt Consolidation
As we saw in the recent housing crisis, one of the biggest risks with taking out a home equity loan is that if your house value decreases then you may find yourself underwater with your mortgage. McClintic recommends homeowners carefully consider how much equity they currently have in their home and outlook for their local housing market.
You should also carefully consider your current and future financial situation to make sure that you will be able to make your payments. If you default on credit card debt or unsecured loans, your credit score will take a nosedive, but missing payments on a home equity loan could result in foreclosure on your home.
While many people cite the tax benefits of using a home equity loan, limitations apply that may make this less of a benefit in many situations. "Interest on home equity loans is limited to $100,000 of debt (or $50,000 is you are married and filing separately for tax purposes)," says Corely. "If the fair market value of your home less your primary mortgages is less than $100,000 (or $50,000) then the interest on home equity loans is further limited." He also reminds homeowners that if they use the money for things other than home improvements then the interest on the loan is not deductible for Alternative Minimum Tax purposes.
If you are still spending more money than you are earning, then paying off your debt with a home loan may just compound your debt problem. Sally Palaian, a psychologist and author of "Spent: Break the Buying Obsession and Discover Your True Worth" says using a home equity loan is best for those who have their spending habits under control. "If they haven't gotten their spending under control, then it's very likely that they end up with a mortgage, home equity loan payment and more debt payments," Palaian says. "If they feel the mess they are in, they are more likely to not create that situation again. Reaching for easy fixes also feeds the immediate gratification problem," Palaian says.