If you feel you are struggling with debt, you are not alone.
The average amount of non-mortgage family debt in the US reached $ 25,104 in 2018, according to the Experian Credit Status Report. The good news is that interest rates on the net worth of housing are still close to historical lows. Assuming you have enough capital in your home, this debt consolidation route could be a better and cheaper alternative to having high interest debts.
Homeowners can borrow against the capital accumulated on their property, often at a lower interest rate than other types of debt. The funds can be used to pay credit cards, car loans or other debts while saving interest money.
“In general, it is a good option to pay off credit card debts or personal loans, assuming it is done responsibly,” says Andrew Weinberg, director of Silver Fin Capital Mortgage in Great Neck, New York. “You can save a lot of money.”
There are two ways to access the accumulated value of the home: a home equity loan or a home equity line of credit, or HELOC. A home equity loan offers a single payment of the funds taken as the second mortgage of your home. A home equity line of credit is a renewable line of credit that allows you to withdraw money over time as needed and pay the loan in monthly installments, keeping access to reuse the available credit.
The net value of your home is your current value less the balance of the loan you still owe. Leveraging your assets too much is risky, and you could end up under water on your mortgage if market conditions change. This means that you may owe more at home than it is worth, which makes it difficult for you to move without putting cash to make up the difference.
“The value of a house goes up and can go down. As a rule, never recommend anyone ask borrow more than 80 percent of the value of your home , “says Mike Zovistoski , managing director of UHY Advisors.
Advantages of using housing capital to consolidate debt
Whether you use a home equity loan or HELOC, leveraging your mortgage capital to consolidate your debt can offer several advantages:
1. You will only have one payment
If you are juggling car loans, personal loans, medical bills and credit card debts, you know how difficult it can be to keep track of due dates. By consolidating your debt, you can combine everything into a single payment per month, simplifying your bills and reducing the possibility of late payments.
2. Know when your debt will pay off
Assuming you do not continue using your cards, using a home equity loan or HELOC to consolidate the debt speeds up the payment process for those accounts. With a home equity loan product, you will have established payment terms and will know the exact date on which the loan will be paid.
3. You can get a lower interest rate
Because the debt is secured against your property, home equity loans and HELOCs have significantly lower interest rates than credit cards. According to Bankrate data, the average variable interest rate on credit cards was 17.47 percent in mid-November 2019. Meanwhile, the average rate of a home equity loan was 5.77 percent and 6.04 percent in a HELOC of $ 30,000.
A home equity loan also allows you to set an interest rate, unlike a credit card that can increase at any time. In addition, with a home equity loan, a majority of your monthly payment goes to capital and not interest.
“It will almost always be a better deal than the fees you will pay on credit cards,” says Weinberg about mortgage-backed products.
4. You can save on interest
The ability to set a lower rate not only saves money in the long term, but can also amount to a lower monthly payment and help you pay off the debt faster.
For example, if I had $ 10,000 in credit card debts at an interest rate of 16 percent, I would pay $ 243 per month and more than $ 4,591 in interest at the time of payment. Consolidating that debt with a five-year home equity loan would not only allow you to pay the debt faster, but also reduce your monthly payments to $ 193 and save $ 3,391 in interest.
“If the borrower can continue to make the same monthly payment amounts that were originally scheduled for high-cost debt, he could pay off the debt in a shorter period of time and save money,” says Zovistoski .
Disadvantages of using the accumulated value of housing to consolidate debt
While a home equity loan or HELOC can be a good way to consolidate and better manage the debt, it carries risks and disadvantages:
1. Take time
Unlike opening a credit card or completing an application for a personal loan, applying for a home equity loan or HELOC is a deeper process. The bank will generally want an appraisal of your home along with two years of tax returns, W-2 forms and bank statements. It can usually take up to 30 days or more to close a home equity loan or HELOC and get access to the money.
2. Your house is the guarantee
HELOCs and home equity loans are forms of secured debt that use your home as collateral. This allows lenders to offer much lower interest rates and more favorable terms than credit card companies, but it presents a greater risk: losing your home if you don’t pay the loan.
While credit card companies and personal lenders cannot search for your home, a bank could execute a mortgage if it does not meet a HELOC or a home equity loan. In other words, don’t take out a HELOC or home equity loan unless you can comfortably pay your payments, in addition to your normal monthly mortgage payment, says Zovistoski .
3. Lender fees and closing costs
Depending on the lender you choose, you will face some charges, such as closing costs and appraisal fees, all of which may increase the cost of the loan. When buying a lender, make sure you understand the closing costs that each lender charges and how it will affect the overall costs of the loans. Some may claim that they do not offer fees, then evaluate the fines if you close the account before the deadline ends, says Weinberg.
4. You can go back into debt
One of the biggest risks is that you can use the accumulated value of the home to pay off your credit card debts only to recover those same cards. People who have a history of debt problems can fall back into that trap. It is not a rare scenario, says Weinberg.
“They can go back in a couple of years and go back to where they were with the most credit card debts,” says Weinberg. “He can only do so many times before running out of capital.”
5. The tax deduction is restricted
Under the previous tax laws, you could deduct the interest you paid on a home equity loan or HELOC, regardless of its use. The new tax law now restricts the deduction of mortgage interest on home equity loans or HELOC to use the money to buy, build or renovate the home against which you are borrowing. Even so, significant savings in interest rates on home equity products compared to credit card fees still make home equity loans a worthwhile option.
Alternative ways to consolidate debt.
Home equity loans and HELOCs are not your only options to address debt. Here are more alternatives for debt consolidation that don’t involve loans against a property you own.
Credit cards with balance transfer
If you have a high interest credit card debt, you can save money on interest with a credit card balance transfer. Banks often offer introductory rates as low as 0 percent for six to 12 months or more. Some cards allow you to transfer outstanding balances of two or more credit cards to the balance transfer card. This can provide a respite from the high annual percentage rates of your current cards and give you time to work on paying the amounts.
If you can obtain a balance transfer credit card with a zero interest period, it is better to transfer only an amount that you can surely pay before the introductory period expires, when a much higher APR will apply.
Low interest debt consolidation loans
Debt consolidation loans are a type of personal loan in which the lender issues a lump sum that he uses to pay off his debts. Instead of having to make multiple payments each month to several creditors, you can make a single monthly payment to the debt consolidation lender. Depending on your credit, you may be eligible for a loan with an interest rate that is substantially lower than typical credit card rates. You will still have debts, but it could be less expensive and easier to manage.
Unsecured personal loans generally have fixed interest rates that can be considerably lower than typical credit card APRs. You can apply for a loan from a bank, a credit union or an online lender and use the money to pay debts with higher rates.
With decent credit, the amount you save on loan costs can be significant. Many people find it easier to manage just one monthly payment instead of paying several credit card bills. However, if your income is not high enough compared to your debt, you may not qualify for an affordable personal loan.
Debt Relief Programs
If your credit is not good, or your debt is high in relation to your income, debt consolidation may not be the best option. You may want to explore debt relief programs instead.
Debt Management Plans
One way is to work with a nonprofit credit counseling agency certified in a debt management plan. It will not damage your credit score, but will require you to close all of your accounts included in the plan. You must make monthly payments to the agency, which in turn makes payments to your creditors. If you have debts with multiple credit cards or lenders, it will save you the trouble of tracking multiple invoices and due dates.
Debt settlement plans
Another option is a debt settlement plan. While you can reduce the balance by agreeing to reach an agreement with one or more creditors for less than you owe, your credit score will be significantly affected. You will also have to pay fees and taxes on the amount forgiven, a consideration that could make debt management less attractive.
It is a good idea to shop around with several different mortgage capital lenders to make sure you get the best rates and conditions. Having a plan on how you will attack high interest debt, and how you will repay your home equity loan or HELOC, can set your finances for a safer future.
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