If you’re struggling with debt, you might be considering whether a home equity loan might help you reduce your debt, and it’s certainly a viable option. But is it the right option for your financial situation? Before you take on new loan debt, it’s important to carefully consider how home equity loans work and how they’ll impact your credit over the long term.
Home Equity 101
When someone says they’re going to take out a second mortgage on their home, what they’re talking about is taking out a home equity loan. And like a traditional mortgage, home equity loans use your home as collateral to provide you with access to a lump sum payment. People frequently take out home equity loans to pay for large expenses, such as home repairs or medical expenses.
Home Equity Loans: Pros And Cons
Access to a lump sum payment is one of the main reasons that people pursue home equity loans, but that’s not the only reason. Compared to other types of loans, home equity loans have high approval rates and low interest rates, and depending on how you use them, they may also carry tax benefits.
Though there are many benefits to using a home equity loan to eliminate debt, it may also be excessive; and the size of the loan can be a problem in its own right. In a breakdown of US consumer debt, the vast majority hold far more mortgage debt than anything else, so if you’ve managed to eliminate mortgage debt, even if you still have tens of thousands of dollars in credit card or student loan debt, you may do better pursuing an alternative debt management or consolidation plan.
In addition to just how much debt you’ll be taking on by opting for a home equity loan to eliminate other forms of debt, it’s important that you have a plan for how you’ll use and repay that loan before you apply, and you should consider alternative remedies. For example, if you have significant credit card debt, you might do better to create a payment plan to manage your debts rather than taking on additional debt via a home equity loan.
Instead of taking out a large home equity loan, you might also consider a smaller home equity line of credit (HELOC). You may still be required to take out a large sum to start, but that amount will still be smaller than a standard home equity loan+ and may be more suitable to the scale of your financial needs.
The overall goal of using a home equity loan to pay off debt is that, because it has a low interest rate overall, you can save money compared to paying off your credit cards, and this may be true. You’ll also know exactly how much you’ll have to pay, and for how long, a definite advantage compared to credit cards with their compounded interest. This is what drives the majority of homeowners to pursue this route if they have substantial home equity but a lot of other debt. A constant payment can be a comfort when facing years of debt management.
Home equity loans can be a great way to pay off other debt, but it will leave you making payments for years to come. Before you rearrange what you owe, though, make sure the balance works out in your favor. Home equity loans can help you improve your credit, but they’re also