In recent years, mortgage rates and home equity rates have been at a historic low. However, interest rates for other types of debt (credit cards, student loans, auto loans) have not always followed suit. It can be tempting to borrow against your home equity to pay off higher-interest debt, but is this a good idea? What should you consider?
What is a home equity loan? A home equity line of credit?
- A home equity loan (HEL) is a lump sum of money lent to you based on the value of your home -- similar to a mortgage.
- A home equity line of credit (HELOC) is also based on the value of your home, but instead of a lump sum, you will receive a revolving line of credit -- much like a credit card.
Both HELs and HELOCs have specific qualification requirements. One requirement is that the homeowner have at least 20% equity in the home. Many other lenders require that the homeowner have a good to excellent credit score.
These loans do not require that the funds withdrawn be used to make home improvements; because of this, many consumers use these loans to pay off high-interest credit card debt, auto loans, student loans, or other debt.
What should you consider when deciding to take out a HEL or HELOC?
There are a few important factors to keep in mind before banking on your home's equity to pay off other debts.
- What is the source of the debt? Will it continue to accrue? If you're paying off credit card bills that were the result of overspending, how do you plan to avoid similar situations in the future? If you're paying off medical bills, has the medical issue been resolved?
- What is the interest rate of the debt you plan to pay off? It doesn't make financial sense to pay off low-interest debt with higher-interest debt, so if you can't find a home equity rate that is less than the interest rate of your current debt, you may want to look into other options.
- What are the minimum payments on the HEL or HELOC? Can you afford them?
- Can the debt you plan to pay off be discharged in bankruptcy? If so, it may be worth investigating a Chapter 7 or Chapter 13 as an option before borrowing against your home. Debt such as student loans, which can be discharged only under very extreme circumstances, may be a better candidate for payoff than other types of debt.
Above all, keep in mind that by taking out a HEL or HELOC, you are putting your home on the line -- don't take out more than you can afford to repay. For more information, visit sites like http://www.firstmortgagecompany.net.