Consolidating and paying off higher-interest debt with a lower-rate home equity loan can help you pay off your debt faster and save on interest. It’s important to understand the risks of consolidating with a home equity loan before applying for one. While using a home equity loan to pay off debt might be the right answer for some, it’s not the right answer for everyone. Explore the pros & cons of using a home equity loan to pay off debt to determine if it’s the right choice for you.
What is a home equity loan?
A home equity loan is a form of second mortgage that enables you to borrow against the equity you have built in your home. You receive the money in one lump sum, and you pay it back in monthly installments. Both the interest rate and the monthly payments are fixed, making for a predictable payment plan.
Pros of using a home equity loan to pay off debt
Tapping into the equity in your home can be an effective way to consolidate and pay off high-interest debts. Here are some of the benefits.
1 Lower interest rate
Because your home is used as collateral for a home equity loan, the interest rate is typically lower than other loan products. For example, while the average credit card interest rate is currently over 20%, a home equity loan rate at Benchmark Federal Credit Union is less than half that. This can mean a significant saving on interest over the life of a loan when used to pay off higher-rate debt.
2 One fixed monthly payment
If you are currently juggling multiple payments every month on different credit cards, consolidating to one fixed monthly payment can be easier and less stressful.
3 A lower monthly payment
Because of the lower interest rate we mentioned above, using a home equity loan to pay off debt can provide you with a lower monthly payment. This can be an added bonus if you are working within a tight budget.
4 You will likely pay off debt faster
Consolidating to a lower-rate loan means a greater portion of each monthly payment goes towards paying down the principal.
Cons of using a home equity loan to pay off debt
While the pros mentioned above may make it seem like using a home equity loan to consolidate debt is the best option, it’s not for everyone. Here are some downfalls you need to consider.
1 Risk of foreclosure
Your home is used as collateral for the loan. While this might not seem like a big deal, it really is. If for any reason you default on your loan, your lender could foreclose on your home.
2 Fees involved with a home equity loan
Certain home equity loans come with hefty fees. This might be something you hadn’t even considered, but it can add up. Fees might include an origination fee, appraisal fee, credit report fee, document and filing fees, title search fees, and more. The amount you save in interest may be outweighed by the added fees.
You should always compare lenders when shopping for a home equity loan. In addition to comparing interest rates, compare the fees involved in borrowing. While some lenders charge hundreds of dollars in fees and closing costs, Benchmark Federal Credit Union has no closing costs* for home equity loans.
3 If you have a problem controlling your spending, you risk piling on more debt
While a home equity loan can help you pay off other debt, it isn’t a cure for a spending habit that is out of control. When paying off debt, you have to refrain from charging up the credit cards you just paid off.
Applying for a home equity loan
To recap, using a home equity loan to pay off debt can be a more effective way to consolidate high-interest balances into one lower-rate loan that provides you with one predictable monthly payment. As we mentioned, it’s not for everyone. If you think it’s for you, check out the home equity loans at Benchmark Federal Credit Union today.
Read “Get a Handle on Debt with a Credit Payoff Calculator.” It will help you run the numbers and make a more informed decision.
If you don’t think a home equity loan is the right choice for you, and the debt you hope to tackle is credit card debt, you may want to consider taking advantage of a VISA balance transfer credit card promo.
* $100 application fee for loan amounts under $25,000