Should you use your home's equity to help consolidate debt?
If you feel like you're drowning in debt, you're not alone. According to debt.org, American household debt hit a record of $13.21 trillion in 2018. Experian's State of Credit Report showed that non-mortgage debt (including such things as credit cards and medical bills, car loans, etc.) reached an average of $24,706 per household in 2017. And a survey by the National Foundation for Credit Counseling in 2018 found that 25% of adults aren't paying bills on time.
So what's the secret to getting out of debt or, at least, managing it better?
If you own a home that has accumulated equity, you could consider consolidating your bills through some type of home equity financing - either in the form of a lump sum loan or a line of credit (also known as a HELOC) that allows you to draw down money as you need it.
What are the advantages of this option?
First, you'll only have one payment to manage. Second, you can get a much lower interest rate. According to Bankrate data, the average interest rate on variable-credit cards in September 2018 was 17.32%. At the same time, the average interest rate on a home equity loan was under 6%.
Sounds like a good deal, right? It can be, as long as you don't keep accumulating more debt and as long as you don't default on the loan. Unlike credit card debt that can be discharged through a bankruptcy proceeding, if necessary, defaulting on a home equity loan could result in foreclosure and the loss of your home. And if the value of your home drops because of changes in the market, you could wind up owing more than it's worth. There are also closing costs to consider when applying for the loan.
Home equity financing does, however, make a lot of sense if handled wisely. When used for most home improvement projects, for example, it offers additional tax benefits, depending on household income. If the loan is used for anything else, such as paying off credit card or student loan debt or personal use, the interest paid is no longer deductible under the 2018 tax reform bill.
The amount you can borrow is based on a number of factors, including the amount of equity in your home, your income and your credit score. The amount you can borrow could be substantially less than your home equity. Most lenders require that you maintain at least 20% equity in your property.
Even if you have sufficient equity, home equity financing might not be the right choice, especially since it doesn't correct the problem that caused the debt initially and could put your house at risk if you're not diligent in repaying the loan. You might be better off with a personal loan to consolidate your debt. Although rates on personal loans are not typically as low as those offered on a home equity loan, they are still substantially less than what is paid on most credit cards. The rate you get depends on your credit history and income. Another option is a balance transfer through which credit card debt is transferred to a card with a lower interest rate.
Credit counseling might also help if poor spending habits need to be corrected.
The information and recommendations contained herein is compiled from sources deemed reliable but is not represented to be accurate or complete. In providing this information, neither Cortland Bank or its affiliates are acting as your agent or is offering you any tax, accounting or legal advice.