Homeownership has many benefits. One of which includes increased equity in your home over time. When you are faced with $40,000 or more of credit card or medical debt each month, tapping into that equity to gain some financial relief can be tempting. Homeowners, however, should be very cautious about using equity for anything, including paying off consumer debt.
While this is one of the most common reasons for taking out a home equity loan or line of credit, it is also potentially one of the most dangerous.
How is Equity Determined?
Home equity is simply the difference between what your home is worth and how much you owe on the mortgage(s). For example if your home is valued at $300,000 and you have a $160,000 mortgage then you have $140,000 in equity.
Home values are most accurately determined by recent homes sales in or around your neighborhood. Sites like www.zillow.com/homes can also give you a ballpark of your home’s value.
All previous loans secured by the property are deducted from this value to determine your equity. The lender will allow you to borrow a percentage of the total value as an equity loan or line.
With equity in your home, you have an asset that needs to be protected. Home equity gives you the ability to sell the home and move to a less expensive location In order to downsize and reduce costs. You can pay off the mortgage to reduce income requirements in retirement. If you access those funds now, you eliminate the leverage home equity provides.
Options Available Using the Equity in Your Home
Cash out refinance is a complete refinance of your first mortgage taking additional funds that can be used to pay off debt. The advantage is that you will get the lowest rate possible as first mortgages offer some of the best lending rates available.
The downside of a cash out refinance is that you have converted high interest debt into a 30 year payoff. With this option you will likely carry that debt long into retirement. For a detailed analysis of cash out refinances see: https://www.strategicconsulting.com/loan-options/cash-out-refinance/
Equity Line of Credit operates like a credit card. You gain a line of credit based on the available equity in your home. You can make cash advances, pay the line back and reuse it at will. Unfortunately, t those with high credit card debt, are most likely to struggle with the temptation that comes from easy access to funds.
The danger is that you can fully utilize the line of credit and then run your credit card balances up again. If this happens you will find yourself in a much worse situation not very far down the road. This is the least attractive option for dealing with revolving credit card debt because of the ease of access to the funds. For more information on the pros and cons of a line of credit go to: https://www.strategicconsulting.com/loan-options/heloc-program/
Second Mortgage operates more like a car loan than a credit card. If you feel the need to use your home equity to pay off debt, this could likely be the best option. The advantage is that you can set the payback period. You are able to reduce the interest rate (though not as low as a first mortgage cash out refinance) and have the debt paid off in 5 years or so. Monthly payments may not decline with the shorter payoff period. You are however, still moving unsecured debt and putting your home on the line in exchange for the lower interest rates. Additionally, the temptation to run up your card balances again exists here as well. Details on the advantages and disadvantages of a second mortgage can be found at: https://www.strategicconsulting.com/loan-options/second-mortgage/
Reverse Mortgage is becoming a popular option for seniors who have not saved enough for retirement. Some seniors are eliminating the mortgage to reduce monthly costs. Others are considering a reverse mortgage to pay off credit card debt. While the loan or line of credit does not need to be repaid, you lose access to your home’s value for future needs. If you sell the home, you are not likely to retain any equity which could be used to purchase another home or downsize.
One of the biggest downsides to a reverse mortgage is the high costs of setting the loan up and the reduced value your home is given. Banks may be looking at holding the debt with accruing interest for a decade or two before they will be paid. Banks must ensure the home’s value will always be greater than the loan plus interest and fees. To learn more about reverse mortgages go to: https://www.strategicconsulting.com/loan-options/reverse-mortgage/
Pros of Using Your Home’s Equity to Pay off Debt
- Lower interest rates than most consolidation options.
- Tax deductible interest payments.
- Ability to extend payments up to 30 years, keeping monthly costs low.
Cons of Using Your Home’s Equity to Pay off Debt
- Converting unsecured debt to secured debt. If you don’t make your credit card payments you will not lose your home. Moving debt to your home equity could result in losing your home if the debt is not repaid in full.
- If you take 30 years to repay the debt, even at the lower interest rates, you could wind up paying more than double the original balances. For example, if you take out a home equity loan at 6% for 30 years you will only pay around $300 a month in payments. However, the total interest over 30 years is $57,919.09 plus the original $50,000. Making the total payback over $107,000.
- Must have good credit to qualify. Those with marginal credit may be able to get approved but the percentage of equity will be lower and the interest rate higher.
- Long qualifying and closing time frame. It can take up to 8 weeks to close a cash out refinance or reverse mortgage and generally around 4 weeks for a second mortgage or line of credit.
- High closing costs. These fees are often rolled into the loan, which means you are paying long term interest on the closing costs as well as the loan balance.
- Could end up with negative equity if home values fall.
- Lose ability to negotiate better terms or lower balances for debts.
Many homeowners want to protect the equity that has built up in their homes. If this sounds like you, consider options that do not convert unsecured credit card debt into secured debt, putting your home at risk.
Credit Card Modification programs offer a professional service that will help you get your monthly payments under control, while negotiating better terms on debt. This could include, but is not limited to, lower interest rates, waiving of fees and late payments, and negotiating lower balances.
The process includes legal representation throughout the process. This additional protection can eliminate collection calls and immediately reduce your monthly payments, giving you breathing room in your monthly budget.
To explore options that leave your home’s equity intact, call Strategic Consulting today for a free evaluation.