Debt Consolidation Home Equity Loan

Debt consolidation home equity loans are still being touted as good solutions to the problem of mounting credit card debt. Given that they usually offer a fixed rate which is lower than most credit cards, they can save borrowers a great deal of money.

There are two ways of tapping into one’s home equity for debt consolidation. The first is a traditional home equity loan, or second mortgage. The second is a home equity line of credit, frequently referred to by its initials, HELOC. Both of these options will be limited by not only the borrower’s credit and income level, but, more importantly, by a set loan-to-value percentage. Typically speaking, lenders prefer to have all debt against a residence add up to a total of 80% of its value or less. That way, in the event that the borrower defaults, there will still be adequate equity to pay off both lenders when the house foreclosed on and sold. In the past, loans at amounts of up to 125% of the value of the home were readily available, although they are much harder to obtain today.

Traditional home equity loans have the benefit of a fixed rate and fixed payments. They also come in a lump sum distribution. If one is borrowing an exact sum to pay off debt, this is a significant benefit. It also prevents one from further dipping into one’s equity for what may end up being impulse purchases.

Using a HELOC as a home equity consolidation loan has two key benefits. The first is that because a HELOC is typically tied to a floating rate, and floating rate loans are currently quite low, the interest rate will be quite attractive. Although this is likely to change in the future, it is a benefit for now, at least. The second benefit is that with a HELOC, one can take out money at will, which means that one does not have to pay interest on the entire line. Interest will just be due on the amount of the credit line that is actually used at any given time. The key problem with a HELOC is that it can make it easier for one to take out more debt at any time, negating any benefit of debt consolidation.

Consolidating debts through a home equity loan can save the borrower a great deal of money. Given a credit card balance of $20,000, one can expect to spend $3600 in interest at 18%. If that balance is transferred to a home equity loan at around 6%, which is a rough average of today’s second mortgage and HELOC rates, the $20,000 in balance would require only $1200 in interest. If that interest is tax deductible, which it should be subject to certain limits, then the value of the tax deduction would be around $400, making the true cost of servicing the debt $800 per year. A wise borrower could take that $2800 in savings and use it to pay the debt down more quickly.