Home Equity Loans for Debt Consolidation, Is This Right For You?

Darcy DoyleBlog, Mortgage Tips

The Mortgage Professionals-15-04_article2-1

What is a home equity loan?  Equity is defined as the value of the home minus any debts that are owed.  A home equity loan is a mortgage loan in which the equity in the home is used as collateral.  So the consumer borrows against the equity in the home up to a certain loan to value percentage as determined by the mortgage company.  Being that the loan is a mortgage product, the rates offered tend to be far more attractive than those of unsecured debt or revolving debt such as a personal loan or a traditional credit card.

 

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What are equity loans used for?  Equity loans are used for a variety of different things.  The most common of these being to consolidate and pay off other debts that are accruing interest at higher rates than that of the equity loan.   Most consumers have multiple credit cards and revolving debt that they are paying monthly payments on and that are accruing interest at very high rates.  Paying the minimum payments on these revolving debts can often result in consumers paying twice, three times and even more than the amount that was originally borrowed simply because the majority of the minimum payment is being applied to the interest owed rather than reducing the principal balance.

Taking out a lump sum of equity to pay off debt can help to significantly reduce the amount of time spent paying the debt back as well as the amount of interested that is spent while paying debts back as well.  Another thing to consider is that consolidation of debt into one payment, with a fixed interest rate, gives the borrower the freedom of only having to worry about making one, often times lower, monthly payment that pays down all of their debt in one place.  Again, being that this is a mortgage product and the interest rates are often much lower than revolving debts, the amount that is being paid monthly is significantly lower.

 

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What should be considered when deciding if a home equity loan is right for you to consolidate debt?

A home equity loan is based on the value of the home minus any balances that are owed, so when you take out an equity loan, you are reducing the amount of equity that you now have in your home.  This is extremely important for someone to consider who is not looking to stay in their home for a long period of time.  If someone is looking to sell in the near future, they will want to consider what profit they hope to make from their home, or if simply eliminating debt is a good option for them.  When they sell, as long as they at least break even between the sale price and the amount of mortgage and the equity loan, essentially all of a person’s debt could potentially be eliminated.

For a person who is planning on keeping a home for a long period of time, or permanently, a home equity loan is a great way to reduce the overall monthly expenses that are going out as well as to save money in interest payments in the long run.  It won’t matter much to them that they are borrowing against the home as they don’t intend on selling the home as an investment for a long time or ever.

It is also important to consider the market conditions when taking out an equity loan.  Is the value of the home high or low?  Real estate trends tend to be cyclical.  The market will rise and fall based on the area that a person lives in.  It’s important to look at the value trends of your home.  How much is it worth now in comparison to the previous few years.  Has the value gone up or down?  Talk with a professional who might be able to forecast what the values tend to do in the future over the next few years.  It is important to consider these factors because pulling equity out of a home at the wrong time could also result in the borrower owing more on the home than it is worth should the value decline after the equity loan is taken out.

A 3d Rendered Illustration showing a Rise and Fall in Interest with symbol percent

A 3d Rendered Illustration showing a Rise and Fall in Interest with symbol percent

How is my decision to take out an equity loan affected by the interest rate staying the same and what could happen in the future should it rise or fall?

The recent decision to keep the rates the same was a great thing for consumers looking to take out an equity loan as they will be able to keep their payments lower with the lower interest rates.  However, it does mean that those considering this as an option should act fast as the rates will not remain low forever.

Should the rate go up, it will mean a higher interest rate on the amount of the equity loan that a person borrows, which ultimately results in a higher payment.  The contrary is also true.  Should rates go down even lower, and one take out an equity loan, the payments would also be lower.

It should be noted that the rates do not affect mortgage holders with current equity loans that are in a fixed interest rate loan, but borrowers with variable rate equity lines of credit will see their payments fluctuate according to the rise and fall of the prime rate as well.

Conclusion: A home equity loan can be a great option to consolidate high-interest revolving debt into one lower, fixed-rate monthly payment.  This option is best exercised when the borrower intends to keep the home for a long period of time, or is not looking to make as much of a return from the equity due to the sale of the home, if their intention is to sell in the near future.  Often times the interest rates on home equity loans are far more attractive than those offered by revolving debt and lines of credit.  Borrowers looking to exercise any of these options should consider doing so while the rates remain low.

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