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home equity loan debt consolidation

How to Consolidate Debt with a Home Equity Loan

Many Americans face varying degrees of debt. In the United States, the average person’s debt, excluding mortgages, is almost $30,000, according to a recent Forbes article. Many people, however, are turning to home equity loans as a way to consolidate their debt.

What Is a Home Equity Loan?

A home equity loan or home equity line of credit (HELOC) are mortgages that enable you to borrow against the value of your home, minus your remaining mortgage, by using your home as collateral.

If you’re approved for a home equity mortgage, the lender will determine how much money you can borrow based on your home’s value and any debts against you. The bank will present that amount to you in a lump sum, which you must then repay at a fixed rate over a set number of years if you have a home equity loan or at an adjustable rate and set term if you have a home equity line of credit. If you default on your home equity mortgage, the lender reserves the right to take possession of your home.

Home Equity Loan vs. HELOC

A home equity line of credit is similar to a second mortgage. This enables you to access the loaned funds at any time you choose, instead of all at once.

You should consider a HELOC if you need money for other items, such as college or credit card payments. You can borrow during the “draw period,” which is usually 5–15 years. The repayment period is about 10–20 years.

All HELOCs are variable rate loans, and advantages include:

  • Paying the interest only on what you draw
  • Interest that only builds on what has been drawn from the line of credit
  • Low closing costs (often less than half of those on a standard loan)

The Advantages of Home Equity Loans

  • Lower interest rates. Home equity loans typically have lower interest rates than unsecured loans, such as credit cards and personal loans. This keeps borrowing costs low.
  • Fixed interest rates. Interest rates are also fixed over the life of the loan, which makes it easier to budget for monthly payments.
  • Easier to qualify. If you don’t have enough equity, it’s easier to qualify for a larger sum of money with a home equity loan than other types of mortgages.
  • A more affordable monthly payment. A home equity line of credit comes with an initial draw period of 5–10 years. During this time, you can use the available credit, and the monthly payment is usually interest-only.
  • Lower your taxable income. Mortgage rates are tax deductible, so a home equity loan or home equity line of credit could lower your taxable income and help you secure a larger tax refund.

The Disadvantages of Home Equity Loans

  • You could lose your home to foreclosure. Since a home equity mortgage uses your home as collateral, failure to make loan payments means you could lose your home to foreclosure.
  • Fees. Depending on the lender, you could pay application fees, appraisal fees, underwriting fees, document preparation fees, closing costs, and more.
  • Your potential return on investment could decrease. If you’d like to sell your home in the future, be mindful of the fact that borrowing against your home’s equity decreases your potential return on investment. This could negatively affect your ability to make a down payment on your next property.

How Much Equity Do You Have in Your Home?

It’s important to understand how much equity you have in your home. Investopedia defines home equity as “the difference between the current market value of your home and the total sum of debts (mainly, though not exclusively, your primary mortgage) registered against it.”

Are You Eligible for a Home Equity Loan?

Requirements vary, but typically include the following:

  • A credit source of 620 or higher
  • More than 20% equity/a loan-to-value ratio (LTV) of 80% or below, as determined by an appraiser
  • A low debt-to-income (DTI) radio (ideally less than 43%, though some lenders may permit a higher DTI)
  • Stable credit and bill repayment history
  • Income and assert verification documentation

How to Get Approved For a Home Equity Loan

If you meet the eligibility requirements outlined above, and if you’re approved for a home equity mortgage, the lender will determine how much money you can borrow based on your home’s value and any debts against you.

If you have questions about how to consolidate debt with a home equity loan, talk to a mortgage specialist. With decades of collective mortgage industry experience, Blue Water Mortgage’s brokers have the expertise to help you make an informed decision. Contact us today to set up a free call and get started.