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ACU Blog  / What is a Home Equity Loan and Can it Help with Debt Consolidation?
12 February 2020 / 4 minute read

What is a Home Equity Loan and Can it Help with Debt Consolidation?

Curious what is a home equity loan? Securing a low-interest home equity loan can put you on the path to financial independence.
Words Allegiance Credit Union
12 February 2020
4 minute read
A home equity loan can help with debt consolidation and save you money like this man banking change.

When hard-working people find themselves swimming in high-interest debt, it’s time to look for a lifeline and pull yourself out. Leveraging your home equity to consolidate monthly payments that are crushing your financial health and quality of life can be a game-changing solution.

Everyday people who wisely invested in residential real estate are widely experiencing equity growth. That is to say that your home value may have exponentially increased during the recent robust economy. It’s also not uncommon for the same people who made the bold move to buy a home to be struggling with credit card fees, student loan debt, and car loans, among other things.

If your stars are financially aligned, securing a reasonably low-interest home equity loan can put you on the path to financial independence. These are essential things to know about home equity loans and their debt consolidation value.

What is Home Equity?

In simple terms, home equity is a homeowner’s real interest in a residential property. In other words, if you subtracted what you owe on your mortgage from the home’s market value, that number would roughly equal the home equity interest you enjoy.

Equity can be established in a number of ways, including the initial down payment you made to secure a home loan. Traditional 20-percent deposits usually reduce the outstanding loan debt. Making ongoing monthly installments on a mortgage also reduces the loan’s principal and generally improves your equity interest in the property.

External factors may also play a role in the amount of equity, in a positive or negative fashion. During the global financial crisis and ensuing recession, home property values plummeted. People with substantial home equity discovered that the market value of their house was now below the principal of their mortgage. This meant home equity was in the negative, or “underwater.” In recent years, the improving economy and booming job market have helped drive home values up. That’s been cause for celebration among homeowners who are experiencing increased home equity without investing additional money.

How to Calculate Home Equity

Figuring out your current home equity does not necessarily require the assistance of a finance expert or accountant.

Start with the appraised value of the property. If you had a routine appraisal conducted in the last year or know the fair market value, that figure should be a good point of reference. Now, gather together all of the debts owed against the home. These include everything, including the mortgage, any liens on the property, and peripheral borrowing, such as a home improvement loan, among others. Add up the outstanding debt and subtract it against the appraised market value.

It’s important to keep in mind this is likely to be a rough estimate. To get a precise home equity amount, it’s in your best interest to consult with a home equity loan professional.

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Pros and Cons of Securing a Home Equity Loan

If you are researching the benefits of home equity loans when it comes to consolidating debt and improving your financial portfolio, chances are the terms “home equity loan” and “home equity line of credit” (HELOC) tend to be bandied about almost interchangeably. For the purposes of debt consolidation, they are not even remotely similar.

A home equity loan provides qualified borrowers with a lump sum that can be utilized to pay off high-interest credit cards, auto loans, and bring your monthly payments under one lower-interest roof. This product is generally paid down in fixed monthly payments that lower the principal, interest, and overall balance.

By contrast, a HELOC offers qualified homeowners a line of credit that you can tap into as needed. These tend to not be the best options for people interested in debt consolidation and improved financial freedom. That’s largely due to the fact that small front-loaded payments may not significantly lower the principal. And, those monthly installments may balloon down the road. These products are uneven methods if used as a type of debt consolidation loan. Sticking with the home equity loan as the preferred vehicle, these are pros and cons everyday people experience.

  • Low-Interest Rates: The interest rates associated with home equity loans are usually far lower than the consumer debt borrowers transfer. High-interest credit cards are a primary driver in securing such debt consolidation loan products. When zeroing-out credit cards by using home equity resources, people can save a good deal of money.
  • Financial Freedom: There are virtually no restrictions on how borrowers use their home equity loan revenue. This opens the door to start a business, pay down debt, or pay for a daughter’s wedding. It’s your money and lenders are content to let you do as you wish with it.
  • Tax Deductible: Like other home loans, these products generally enjoy tax-deductible status. However, when using the loan as a tax deduction, there are prescribed limits.
  • Easy To Qualify: Given you have already qualified for a mortgage and are in good standing, the process can be much more straightforward. The pertinent issues are usually just loan amount, interest rate, and ability to repay.
  • Length of Repayment: Standard home equity loan products are usually repaid over 5-15 years. That is longer than many other loans.

The pros certainly make home equity loans an attractive option for people interested in debt consolidation. But that does not necessarily mean this particular loan option is right for everyone. Take the time to consider some of the following negatives as well, before making an informed decision.

  • Risk: It’s important to keep in mind that you are leveraging the equity in your home as collateral. Failure to repay a home equity loan could result in foreclosure.
  • Piggy Bank Effect: It’s not uncommon for homeowners to take a second and even third home equity loan after successfully paying off the first. This may lead to frivolous spending and overspending.
  • Costs and Fees: Home equity loans can act as a second mortgage. They also require similar closing costs and application fees to be paid. Some products also have early payoff fees built into them. It’s crucial to work with a reputable lender who spells out the fine print, charges the lowest fees, and gets you the best rate possible.

In many cases, a home equity loan makes sense from a debt consolidation perspective. But before applying, it’s important to ask yourself whether this type of borrowing truly improves your financial exposure.

Does a Home Equity Loan Make Sense for Debt Consolidation?

If, for example, your financial struggles are the result of an unexpected work shortage or illness, a home equity loan is unlikely to fix the root problem. It may be better to weather the financial storm and consider using a home equity loan as a debt consolidation solution once you have secured adequate employment or are back on your feet. On the other hand, if you are bringing in a reasonable salary to cover living expenses and have allowed spending to get out of hand, this could be the best choice. Of course, becoming more fiscally responsible will also go a long way toward avoiding further indebtedness. If you are unsure if a home equity loan is the right debt consolidation solution for you, speak with a professional today about your financial situation.

For more details to help answer your question, "What is a home equity loan?", review our "Definitive Guide to Using Home Equity Loans for Debt Consolidation".