Woman calculating savings when using a home equity loan to pay off debt.

Mar 04, 2015 / Home Equity

Use a Home Equity Loan to Cut Debt Costs

Paying off credit card and other types of short-term debt can be liberating. But trying to get debt-free can seem hopeless, as interest charges accumulate even when you make hefty payments. If you’re a homeowner whose house is worth more that the mortgage and you’re committed to ending the cycle this year, using your home equity might be a useful option to pay off balances owed on other accounts. Here are five things to expect from a home equity loan or line of credit:

Save Money

Most people choose this approach to reduce interest costs and save money. But borrowing against your home often involves some of the same fees you pay when getting a first mortgage, such as for an appraisal, so determine what these will amount to when figuring out the savings. Also, keep in mind that using your home as collateral puts it at risk should you fail to make your payments.

Lower Monthly Payments

Although a home equity loan or line of credit won’t magically make debt disappear, it will usually cut the interest rate you pay, and the interest may be tax deductible. Lenders like Utah First Credit Union offer annual percentage rates as low as 3.99% on home equity lines of credit, or HELOCs, and even cover many of the fees and costs involved in the transaction, provided you meet certain qualifications.

Simplifying Obligations

If you’re carrying balances on multiple cards and struggle to keep the payments organized and make them on time, consolidating those debts with home equity financing can simplify things by shifting what you owe into a single obligation. This way you’ll have just one payment to make each month, which can help you avoid penalties associated with missing a payment.

Loan or Credit Line

Generally a home equity loan provides the borrower with a lump sum upfront with a fixed term of repayment at a specific interest rate, so you know what the monthly amount will be for the life of the debt. By comparison, a HELOC generally provides a maximum amount that can be borrowed over a fixed time period, with rates that can change based on a market index, such as the prime lending rate. Some lenders provide ways to lock in a HELOC rate for a set amount of time, giving you more cost certainty.

Read the Fine Print

It’s important to know the terms involved to make sure you’re choosing the best course for your situation. With your home at risk of foreclosure action if you fail to repay the debt, make sure you can cover the monthly payments and how much they can increase if the rate can vary. Do your homework to find the most economical alternative.
Using the equity you have in your home to finance debt consolidation can be a good way to cut your costs. But it’s important to study all your options and their potential consequences before you make a commitment.

Cait Klein, NerdWallet
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