The second debt consolidation solution in our blog series is the Home Equity Loan. Here is a quick reminder of all the debt consolidation options we will cover, and in the order they will appear:
Home Equity Loans
A home equity loan functions similar to an unsecured debt consolidation loan but it requires you to secure the debt against your home. This security reduces the risk of the lender because if you don’t make payments they can take your house. The reduced risk also lowers the credit score requirement. Your credit score doesn’t need to be great in order to be approved for a home equity loan. However, the low risk for the lenders raises the stakes for you – losing your home for missing payments is a very serious consequence.
This debt consolidation option is managed and executed by you – there is no third party involvement. It is not a recommended plan for dealing with financial difficulty. Just as the unsecured debt loan is unadvisable, the home equity loan isn’t advisable because it is an attempt to borrow your way out of debt. This is a highly risky option for paying off unsecured debt because you run the risk of losing your house.
How Home Equity Loans Function
The main benefit of a home equity loan is quick cash. If you are approved you will receive a check for a lump sum that you can use in any way you wish. As a debtor, you will use it to pay off your debt. This option allows you to eliminate your various debts and consolidate all of your debt into the home equity loan. Going forward you will only have one monthly payment (if the amount of your home equity loan is enough to pay off all of your debts).
You must own a home to get a home equity loan. Here is how you estimate how much money you can borrow against your house:
- Determine how much your home is worth
- Take your estimate times 0.8 to determine how much money is available to act as collateral on the loan
- Determine the outstanding balance on your mortgage and subtract it from your estimated collateral available
If your calculation result is a negative number your chances of being approved for a home equity loan is slim. There are additional factors that are taken into account as well. Your credit score is one factor, although there is some leniency you still need to have a fairly decent score for a lender to give you money. Your debt-to-income ratio is also considered – generally speaking your total monthly debt payments must be at or less than one third of your gross monthly income. Finally, the state and worth of your home will be taken into account. An appraiser will visit your home to calculate the true value of your home to determine the exact amount you can borrow.
The Danger of Home Equity Loans
If you are considering a home equity loan as a debt solution you need to know the aftermath and consequences that may occur. If you are able to make full AND timely payments this may be a viable option for you. However, if you are having debt issues and financial struggles, full and timely payments are probably a challenge. This is not a good option, in these circumstances because your lender can foreclose on your home if you miss or make inadequate payments.
Despite the immediate advantages of quick cash, one monthly payment and a lower credit score requirement, a home equity loan is not a smart debt consolidation solution because the risks are so high.