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Should you use home equity loans for debt consolidation?

Should you use home equity loans for debt consolidation?
(Image credit: Getty)

When it comes to household finances, it’s far from unusual to find people who are equity rich yet comparatively cash poor. If you’ve made sensible use of the low rates that the best mortgage lenders can provide, and property prices move in the right way, there’s a good chance you’ll have a decent amount of equity built up in your home in only a few years. 

At the same time, however, there’s still the distinct possibility that you’ll have accumulated debt over the years as part of your everyday life - perhaps you borrowed on a credit card during a spell out of work and never paid it back, or you took out a personal loan and the payments have weighed heavy ever since. Without realising, you might quickly have three, four or five debts to your name, together placing a strain on your income. So is it wise to make use of the value that has built up in your home and use home equity loans for debt consolidation?

Should you use home equity loans to consolidate debt?

 In some cases, using the equity you’ve built in your home is a good option when it comes to consolidating your other debt. This is especially true if you’ve owned your home for a while and can qualify for the best home equity loan rates. While you’ll always need to check for yourself, these are often lower than the interest rates that you’ll be charged for a debt consolidation loan. 

That said, there are other costs associated with most home equity loans that need to be taken into account too. Most have closing costs that can cost up to a few thousand dollars, and if your alternative from one of the best debt consolidation companies is essentially a personal loan, with few or even no fees attached, the consolidation route could easily work out cheaper. 

Should you use home equity loans for debt consolidation?

(Image credit: Getty)

Other home equity considerations

The biggest risk with a home equity loan is that your home is used as collateral, so a failure to make payments on time can result in your home being foreclosed. Debt consolidation loans, on the other hand, are usually unsecured, meaning they don’t require collateral to be put forward, and that the roof over your head will not immediately be at risk if you fall behind with what you owe. 

Also remember that lenders use a loan-to-value calculation to determine how much they’re actually willing to lend you. So if the capital you’ve built up is not enough in the eyes of the lender, the amount they’ll loan against your home’s equity may not be enough to consolidate all of your debts. If your home equity isn’t to the point where it would cover your debts, a debt consolidation loan, which could potentially offer higher limits, might be a better option. 

Alternative ways of consolidating debt

If it's credit card debt that you have to your name, it’s always worth finding out if a balance transfer credit card might be a viable option before taking out a home equity loan or a debt consolidation loan. By switching your existing credit card debt to an interest free balance transfer credit card, you’ll buy yourself time to start paying off what you owe without any further interest being charged. 

There’s usually a fee to transfer the balance, of somewhere between 3% to 5% of the amount you’re bringing over, but if you’re then saving on interest payments, it could easily represent the best option financially. The challenge then is to try and pay back what you owe before the 0% grace period ends and the interest rate on your new card kicks in. If you can, your debt could be cleared, and the equity that has built in your home will remain intact for another day. 

Learn more about consolidating debt and where to start, along with the other consolidation options that might be available to you. 

With over 20 years’ experience in the financial services industry, Tim has spent most of his career working for a financial data firm, where he was Online Editor of the consumer-facing Moneyfacts site, and regularly penned articles for the financial advice publication Investment Life and Pensions Moneyfacts. As a result, he has an excellent knowledge of almost areas of personal finance and, in particular, the retirement, investment, protection, mortgage and savings sectors.