If you’re like many other Americans in debt who own a home, you’ve probably asked yourself, “is a home equity loan a good idea for debt consolidation?” Consumer debt is approaching $14 trillion in the United States, with over $800 billion in outstanding credit card debt. One of the ways consumers are choosing to address the high-interest debt they’re saddled with is by using home equity loans. Home equity loans can be an effective way to consolidate outstanding debt and get on the path to becoming debt free. While the risks associated with them are higher, the interest rates and monthly payments are often lower than what you typically pay with other forms of debt, making them a very attractive option.
What Is A Home Equity Loan?
A home equity loan is a loan issued based upon the value of the equity in your home, and it uses the home as collateral for the debt. Because of this, home equity loans are often referred to as secured loans. There are two basic types of home equity loans: a standard lump sum payment, and a home equity line of credit, or HELOC, which gives you a pre-approved credit limit that allows you to choose how much you borrow against the equity you have in your home. Many lenders offer both of these types of loans to consumers as a way to consolidate their outstanding debts.
This table provides a side-by-side comparison of home equity loans and standard unsecured debt consolidation loans, and the overall differences between these loans will be discussed at length in the paragraphs that follow.
| Home Equity Loan | Standard Debt Consolidation Loan | |
|---|---|---|
| Type of Loan | Secured by borrower's home | Unsecured |
| Interest Rate | Lower | Higher |
| Monthly Payment | Lower | Higher |
| Tax-deductible Interest | Yes* | No |
| Risk to Borrower | Higher | Lower |
*Before making any decisions about your tax returns, ensure you discuss your eligibility to deduct interest on your home equity loan or home equity line of credit (HELOC) with a tax professional.
The Benefits of Home Equity Loans
As you ponder whether a home equity loan is a good idea to consolidate your debts, it’s important to look at their many benefits. One of the biggest advantages these loans offer relative to standard debt consolidation loans is that, since they’re secured with the collateral of your home, most lenders offer them at lower interest rates than other types of loans. A lower interest rate means your monthly loan payments should be lower. In some cases, due to high levels of outstanding debt and/or a low credit rating, getting a secured loan such as a HELOC or home equity loan may be a borrower’s only choice for debt consolidation. Finally, borrowers will often be able to deduct the interest from their home equity loans when filing their income taxes, too.
The Drawbacks of Home Equity Loan
While there are some terrific advantages to using a home equity loan for debt consolidation, there are also some drawbacks to these types of loans to consider. The biggest disadvantage to home equity loans and HELOCs is the overall risk. Unlike with a standard unsecured debt consolidation loan, if you’re unable to continue repaying your home equity loan, you could risk foreclosure and lose your home. Additionally, if home prices in your area drop substantially, you could end up owing a substantial debt. So, as you consider if a home equity loan is a good idea for debt consolidation, ensure that you’re so confident in your ability to pay the loan back that you’re willing to put your house on the line.
Ensuring Home Equity Is a Good Fit
Another thing to consider before choosing to consolidate your debt with a home equity loan is whether that loan will truly help you address your debt issues. If you rely heavily upon credit card and revolving debt due for your personal spending habits, for example, then consolidating your debt won’t do anything to address the root causes that got you into debt in the first place. Moreover, if your debt issues have recently become more serious due to a cut in hours or pay at work, or a job loss, then taking out additional debt with a home equity loan may put you in an even more precarious financial position.
If this is the case, some other method, such as the debt settlement, may be a better choice for you. If you’re altogether unsure how to move forward and address your outstanding debts, talking to a debt counselor or some other trusted financial advisor is a great way to determine if a home equity loan is a good fit for your personal financial situation.
So, is a home equity loan a good idea for debt consolidation? Absolutely! However, before you decide to take out a home equity loan, talk to a trusted financial advisor first. A good advisor can assess your current financial situation and determine the best way to use a home equity loan to deal with your debts, so you can get on the path to being debt free forever.
