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All You Need to Know About Using Home Equity Loans for Debt Consolidation

As a homeowner, you have options as long as you have equity in your home. Even if you have not paid your home off, you likely have equity that you can use to meet your other goals. If you have found yourself in a situation where your debt is climbing and you cannot get control of it, your home equity may be the answer you are looking for.

A great option that people use in this situation is a home equity loan. This is a loan that you take against the equity you already have in your home. It is a great option because it is your money already, it is simply tied up in your home. If this sounds like something you are interested in learning more about, continue reading so you can decide if it is the best course of action based on your current situation. 

When Do You Need to Consolidate Your Debt?

Having some kind of debt is normal for most people these days. Whether it is your home mortgage, student loans, or even a few credit cards, all of that can quickly add up and become overwhelming. There are two main reasons to consolidate your debt.

The first is if you simply have too many accounts to keep track of and have missed some payments or come close to it simply because you could not keep track of it. This can be a big issue if you are not staying on top of your payments. Not only does it lower your credit score but it also can get you behind on your financial obligations. If you let it get too far, it can be hard to bounce back from that.

The second reason is if your payments are too high for you to manage or if your interest rate is too high and it is taking a lot longer to pay it off because of it. High payments can easily overwhelm you and you can run into the same problems as mentioned in the first scenario. High interest rates can prolong the time you are actually paying on your debt. The higher the interest payment is, the more you will end up paying in the long run.

If either of these scenarios describes what you are currently going through, it may be time to consider debt consolidation. By consolidating your debt, you can get a lower interest rate and you only need to make one payment for the debts that have been rolled up into it. Many times, this payment is less than all of the payments combined separately because the interest rate has been lowered.

When considering debt consolidation, you need to have all of the account information for the debts you would like to consolidate. You will need the total debt owed, the interest rates for all of the different debt you have, and who you owe the money to. Once you have that information, you are ready to find the best option for debt consolidation that meets your needs.

For more tips on consolidating your debt quickly, review our blog "How to Get Out of Debt Fast - 5 Proven Tips." 

How To Set Goals for Debt Consolidation

Now that you have a good understanding of debt consolidation and how it can be beneficial, if it is something that you are considering, you will want to do everything you can to prepare for it. The main goal of debt consolidation is to lower your payments and interest rate. To do this, you need to have a good credit score. The better your score is, the better rate you will get and you will be able to meet your goals faster.

If your score is not ideal for this right now, your first goal should be to work on your credit score. Try to find things that you can do to increase it. Some common things you can do for your credit score is get current on all of your debts, continue to make payments on time, and even find ways to pay a little bit extra to lower your credit utilization, if applicable.

You should also take some time to view your credit report to make sure there are no errors in it. If you do find errors in your credit score, take the appropriate steps to dispute them with the credit agencies. Of course, you should only dispute anything that is actually incorrect. You should not be disputing an item simply because you do not like it. You will not have success if the debt is a valid debt so it is best not to waste your time trying to remove anything legitimate.

The next goal you should work on is gathering everything you need for debt consolidation and determine what debts you would like to consolidate. Once you have done these things, you can start to look into your options for debt consolidation. 

For more debt consolidation tactics, review our recent blog "The Truth About Debt Consolidation."

What is a Home Equity Loan?

A home equity loan is a second mortgage. You are able to take a lump sum out of your existing equity in your home and can use it to put it towards your debt. People do not always put it towards debt and another popular option is to use it for home renovations. However, using this type of loan for debt is a great option because it is already your money and you are essentially borrowing from yourself to pay off other debts that you owe.

It is also a great option if you do not have great credit because these types of loans offer lower interest rates than opening up a credit card to consolidate debts or even getting a personal loan. In the long run, this type of loan will allow you to get more out of the money and pay back less than you would with other options in the market. Unfortunately, this type of loan does require that you have equity in your current home.

If this is something that you do not have, you will not have success with applying for this loan since you do not have anything to borrow from. However, if you do have equity in your home, this is a great option that will allow you to save money while paying down your other loans. When compared to other debt consolidation options in the market, this is a great one to consider if you are able to do so. 

For more specific details on whether Home Equity Loans are the right solution for you, review our recent blog "What is a Home Equity Loan and Can it Help with Debt Consolidation?"

How Does a Home Equity Loan Work?

When your home is valued at a higher amount than your current mortgage, you automatically have equity in the home. You can also have equity in the home if you have been paying it down for several years. These two situations can work to your benefit in tandem or you may only have one of these situations that you can use to your advantage. Either way, having this equity is the first step in being able to get a home equity loan.

When you take out a home equity loan, you will take out one large sum from your equity and then you will repay the loan every month over a set period. This is often 5-12 years depending on the loan parameters.

In order to get this loan, you will need to fill out a loan application. The loan application should be through your bank or credit union. You will need to prove your equity in the home. If this is due to increased prices in the market, you will need to have your home appraised.

When completing your loan application you will need to provide the reason you are taking the loan out, your credit information, your equity information, and possibly include the debt information that you will be consolidating. All of this information is crucial to the application process so that you have a better chance of being approved and working to better your financial situation. 

For more specific details on how Home Equity Loans work, review our recent blog "How Does a Home Equity Loan Work and How to Use it to Consolidate Debt."

Home Equity Loan vs HELOC

If you are researching home equity loans, you have likely also seen information about Home Equity Lines of Credit (HELOC). There are some major differences between a Home Equity Loan and a HELOC and you should understand them so you know what you are getting into when applying for either of them.

With a home equity loan, you will take out one large sum at the beginning of the loan, as described before. In most cases, you will have a fixed interest rate on this loan. You will not be able to add more to this loan amount without going through the application process again, which is why it is important to know exactly how much you will need when you are applying for the loan. This loan is also for a set term typically for between 5 and 12 years.

A HELOC is a line of credit against your home. Instead of being like a fixed rate second mortgage, you will actually apply to be approved for a line of credit that you can borrow against up to the limit of the approved line of credit. You will usually be approved to borrow against this line of credit as needed for the next 12 years. Since you do not need to take out everything in one lump sum, this type of credit line tends to be better for renovations than for use with debt consolidation.

Another thing to note with a HELOC is that more of the interest rates are variable which means that your interest rate will change with the market over time. It will function like a credit card and you will need to pay down the amount taken against the line of credit over time and can make extra payments over time and then re-borrow if needed during the time frame. You will still need to make payments on time every month as outlined in your agreement. 

For more information on which type of equity loan is right for you, review our recent blog "Home Equity Loan vs HELOC - Which is Best for Debt Consolidation."

Home Equity Loan Calculators

One of the biggest components to consider if you can get a home equity loan is figuring out if you actually have the equity that you can borrow against. This is not something that you will want to guess on as you should have some solid data to back your claim in your loan application. A lot of banks will not loan more than 90% of the current value of the home, minus what is still owed on the mortgage.

Because of this, you will want to know exactly how much you have available to see if this is a viable option based on your needs. It is a multiple-step process to best determine the equity in your home. You will need to take a look at the current value of your home. If you are not sure what this is, get a realtor to give you an estimate, since the credit union will require approval.

Then, you will need to subtract your outstanding mortgage amount from the total value of the home. Once you have that number, you will be able to determine if there is equity in the home.

If the number is positive you have equity in your home. If it is negative, you do not have equity in your home.

For example, if your home is valued at $400,000 and your current mortgage that still needs to be paid off is $200,000, then you have $200,000 in equity. Now that you have this amount, you can then multiply the total by 90% to get the value. You will then subtract that from your outstanding mortgage amount and you will have the amount you can expect most banks to potentially approve you for. 

Of course, you will need to work with a bank or credit union to figure this out with you as well. They will want to be involved in the process. If you are looking for a calculator that you can use to help you with these calculations, you can start with our calculator on our website. Using this calculator will help to simplify this process for you. 

When You Should Use a Home Equity Loan for Debt Consolidation

One of the things to take a look at is the type of debt you have when you are considering it for debt consolidation. You can examine your current interest rates to determine if the debt you currently owe will benefit from the interest rate you get from a home equity loan. Debts with higher interest rates than the interest rate you are offered for your Home Equity Loan are ideal. However, there may be other circumstances, such as the length of the loan, that may play into your decision. 

Once you have decided that this can work for you, you will need to see what kind of rate you can get. If your interest rate is higher than the interest rates you are currently paying, you may want to consider another option. Personal loan rates can be very high so many people do not consider them as an option. However, rates for home equity loans can be very reasonable, especially if interest rates are as low in general as they are right now, and likely will be a great option as long as your credit score will qualify you for the lower rates.

These are all very important things to consider because without everything lining up correctly, you may end up paying more in the long run with a home equity loan. Consider these variables before moving forward with this type of loan.

Additionally, you should work on developing a budget so you can live within your means. As a goal, you should do this to avoid building up more debt after you have consolidated it through your Home Equity loan. 

For more mistakes to avoid when taking out a loan to consolidate your debt, review our recent blog, "7 Mistakes to Avoid with Your Debt Consolidation Loan."

How Home Equity Loan Rates Impact Using it for Debt Consolidation

In many cases, you will find that the interest rates for home equity loans are lower than other debt consolidation tools in the market. This makes them very favorable for many homeowners that are looking to combine their debts and pay them off faster as a result. While you technically can use this type of loan for anything as long as you present this plan to the lender, many lenders do favor applications that have a plan to better the financial position of the applicant.

Because of this, some lenders may offer a slightly lower interest rate because of what the plan for use of the money entails. This is not always the case as each lender is different but it is something to consider, especially if you are planning to use the loan for a large debt consolidation to better manage your finances. You will want to be clear with your lender on the use of the money and inform them that you will plan to use it for debt consolidation as well as how this can help you meet your financial goals. Because this is a common use for this type of loan, it is a common request that many lenders will take into consideration.

Consider accessing the equity in your home with a Home Equity Loan at Carolina Trust Federal Credit Union. We will help you find a loan term and payment that fits your needs. Click here to learn more.