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Debt Consolidation Loan

Consolidation Loan Guide Step 3: Pros and Cons of a Home Equity Debt Consolidation Loan

    You've seen the advertisements for debt consolidation, the ones talking about lowering your monthly payments while saving you money. Well, they're usually talking about home equity debt consolidation loans. A home equity debt consolidation loan can be a very useful tool for getting debt-free quicker and for less money, but there are some risks involved. So, before you jump at advertisements about lower interest rates, reduced monthly payments and tax deductions, make sure you have all the facts. Like anything in life, a home equity consolidation loan has its pros and cons. To help you weigh the costs and benefits and decide if one is the solution to your debt problems, here is what you should know.

Pros of a Home Equity Debt Consolidation Loan

  • Easier to Obtain: All other things being equal, it is much easier to obtain an equity-based consolidation loan than other types of consolidation loans (Sutton). To understand why that is, think of it from the lenders point of view. Would you give out an unsecured loan, which means you have no assurance of being paid back, to just anyone? You'd be wise to say no. But, if you were assured to get your money back by selling the person's house if they couldn't make the payments, wouldn't you be more likely to loan your money? Of course. That's how a lender sees things. Lenders weight the risk versus the opportunity to make money when considering whether to give out a loan. So, with equity-based consolidation loans lenders are taking less of a risk because they get your house if you can't pay. That assurance is why lenders are more willing to give out a home equity debt consolidation loan than other types of consolidation loans.
  • Lower Interest Rates: Another plus of getting a home equity debt consolidation loan is that it will usually cost you less money than other types of consolidation loans because equity loans have lower interest rates (Antonini). The reason they have lower interest rates than other types of consolidation loans is the same reason for why they are easier to obtain: for lenders, they are less risky. Lenders charge higher interest rates for high-risk loans and low interest rates for low-risk loans. Whether you have bad credit, no collateral, unstable income or no job, lenders see you as a financial risk and will charge you very high interest rates to protect themselves from loosing money. On the other hand, if you have good credit, use your home's equity for collateral and have a good job, you'll get low interest rates.
  • The Interest May be Tax Deductible: The government, whether local, state or federal, likes to encourage people to buy houses and set down roots. To promote that, they often provide tax incentives. One of those incentives is that the interest payments on your mortgage or equity line may be tax-deductible (Michael). If you need a debt consolidation loan, why not get some money back while you're at it?

Cons of a Home Equity Debt Consolidation Loan

  • Your House is on the Line: The most significant drawback of a home equity debt consolidation loan is that you can loose your home if you can't make your payments (Downey). You must be very, very careful whenever your house is used as collateral for a loan. Absolutely make sure you don't charge up more debt, whether on credit cards or any other form of loan. Only put your house on the line if you are sure you're on your way to being debt-free and that you can make all your payments. Don't run the risk of loosing your home by defaulting on your loan payments.
  • Spending Your Equity: When you use your home's equity to pay off other debts, you deplete one of your most valuable assets (Sutton). Your equity is especially valuable because it retains or gains value, unlike other goods, such as cars, which loose value. So, when you use your equity to consolidate other debts from credit cards, auto loans, boat loans or other types of debt, you're sacrificing a valuable asset for things that loose value. Financially, it isn't a good decision to trade something that retains and increases in value for something that looses value. Ideally, your equity should only be used to invest in profit making enterprises.

    Always weigh both sides when deciding whether a financial option is right for you. Give the decision careful consideration, and if you a home equity debt consolidation loan seems like the best option for you, make sure you're on the path to being debt free. Don't risk loosing your home.


The Rest of Our Consolidation Loan Guide:


Sources:

Antonini, Orlando J. Getting a Business Loan. (Massachusetts: Thomson Crisp Learning, 1993). 67-70.

Downey, Tom. The Standard & Poor's Guide to Personal Finance. (New York: McGraw-Hill Professional, 2005), 37-38.

Michael, Jeff. Repair Your Credit and Knock Out Your Debt. (New York: McGraw-Hill Professional, 2004), 49-51.

Sutton, Garrett. Rich Dad's Advisor: The ABC's of Getting Out of Debt. (New York: Warner Books, 2004), 27-33.