Before Going for a Home Equity Debt Consolidation Loan

A Credit Article Contributed by Mark Mcclelland

What, Exactly, are Home Equity Debt Consolidation Loans

What do you call the process of taking out a loan against the equity you've build up in your home in order to finance your debt consolidations plans? Well, a debt consolidation home loan, of course. Combining a number of separate debts, each with it's own monthly payment, into a single debt with a single monthly payment, is not only a smart thing to do, but if it can be achieved by using the equity you've already established in your most valuable asset, it can be an even smarter move. But, as in all things financial, there are pitfalls to this approach, so read on.

If you want to get out from under the pressure of all the credit card bills, a home equity debt consolidation loan may be a useful source of funds. These loans provide you access to credit when you write checks against the credit line. You can use these funds to pay off your balances in part or in whole as you get the credit card bills in the mail. But these types of loans require that you use your home a collateral, and this may put your home at risk if you can't make your monthly payments for some reason or another in the future.

And there are other ways to get funds to finance your debt consolidation plans as well. You might be able to get a second mortgage. While this will also place an additional mortgage on your home, second mortgages are usually loaned as a lump sum, rather than in a series of credit advances made when you write checks against the loan. In addition, second mortgages typically have fixed interest rates and a fixed payment plan, just like your first mortgage.

How Big of a Home Equity Loan Should You Get for Debt Consolidation Purposes?

If you've decided that a home equity based debt consolidation loan is the best option for you, you need to decide how much you're going to ask for.

In most situations, and if you have enough equity available, you should borrow an amount that will pay off all of your credit card balances due, but no more. However, the specific amount you should borrow, and the amount you can borrow, are likely to be quite different.

For example, in you live in Texas, you can only borrow money using up to 80% of the fair market value of your home as collateral. What this means is that if your home's fair market value is, say, $100,000, your equity in the home is $30,000, and you have an outstanding principal balance due of $60,000, you can only borrow $20,000. How was this calculated? Well, in spite of the fact that the home is worth $100,000, you can only borrow against 80% of that, or $80,000.

So the calculation is $80,000 - $60,000 = $20,000. So you can see that in this case, in Texas, you can only borrow 2 / 3 of your actual equity...and that may not actually be enough to pay off all your credit card balances due.

But on the other hand, it may be enough to wipe out a couple of those really high interest rate cards, with the home equity loan monthly payment being less than the combined monthly payments of the cards you paid off. You can then use the savings to start making a bigger dent in your remaining cards.

Briefly What are the Primary Benefits and Detractions of Home Equity Debt Consolidation Loans?

Well, there are several benefits: first, the interest rate is almost always fixed at a lower rate of interest than your credit cards; also, because the home equity loan is secured by real estate, the interest is often tax-deductible; and finally, your monthly payment is likely to be a lot lower than the combined monthly payments of all the debts you can wipe out.

The primary detractions of home equity loans are: with a home equity loan, you're essentially betting that you won't ever have a problem making the monthly payments; in addition, there's nothing to prevent you from jumping right back into that hole of debt as soon as you've paid off your cards; and finally, a home equity loan essentially eliminates most of the flexibility you may have had when you decide to sell your house, especially if your home equity loan exceeds the actual value of the home.