Home Equity Loans
A home equity loan, also known as a second mortgage, allows the owner to use some or all of the equity in their home as collateral for a new loan.
Home Equity Loan vs. Home Equity Line of Credit (HELOC)
A home equity loan differs from a home equity line of credit (HELOC). A home equity loan pays out a lump sum up front and typically has a fixed interest rate and equal monthly payments.
Disadvantages of Using a Home Equity Loan to Pay Off Debt
If you are a homeowner with debt from various sources – such as credit cards, student loans, and auto loans, for example – it may seem appealing to use a home equity loan to pay them all off, leaving you with just one payment instead. However, it is a financially risky decision. Let’s look at two main reasons why this path is not recommended.
Better Options for Paying Off Debt
Let’s explore other ways to reduce debt that may be more suitable for you.
Budgeting
If you have room in your budget, trimming expenses could be a viable alternative to using a home equity loan to pay off debt. This starts with setting up a budget and ensuring you know how much money is coming in and going out of your accounts each month. Note the expenses you can cut back on, make a plan to reduce them, and do your best to stick to it.
Debt Consolidation Loan
Debt consolidation means using one loan to pay off all other debts so that you only have one payment to make each month instead of multiple payments. It doesn’t eliminate the debt, though it can make managing it simpler. A debt consolidation loan is a personal loan specifically designed for consolidating debt. It may be hard to obtain or carry a higher interest rate than a home equity loan. But if you can secure a consolidation loan at a lower interest rate than your remaining debts, you may be able to reduce the overall monthly repayment cost this way.
Balance Transfer Credit Card
If most of your debt is on credit cards, you might consider transferring your balance to a balance transfer card with a 0% interest offer. These promotional rates don’t last forever, but some of the best balance transfer offers last for over a year and a half. As with a consolidation loan, it may be difficult to obtain a balance transfer card from a home equity loan. There are usually fees associated with balance transfers, so calculate whether you will actually save money after accounting for those fees. If you cannot pay off your debt during the promotional period, a balance transfer card may not be the right option for you. The increased interest rate after the promotional period may be worse than what you started with.
Debt Management Plan
You may want to work with a credit counselor who can help you create a personalized debt management plan (DMP). The credit counselor should be certified and trained in debt management, credit, and budgeting. Most trusted financial counseling agencies are nonprofit organizations. When choosing a credit counselor, check with the National Foundation for Credit Counseling or the Financial Counseling Association of America to find an agency in your area. You may also be able to find credit counseling through a university, military base, credit union, or housing authority. The counselor should review your entire financial situation before determining the right plan for you.
Source:
https://www.thebalancemoney.com/how-not-to-pay-off-debt-1289620
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