Using your home equity to pay off your debt is a major decision, and there are many reasons why you should not do it.
One of the biggest reasons is that you can negatively affect your credit score.
Using your home equity to pay off your debt can lower your credit score by 100 points or more.
How do you think about using your home equity to pay off your debt? In this article, I will give you 4 reasons why you should avoid using your home equity to pay off your debt.
1. Your home equity is not a piggy bank
Most people think of their home equity as a piggy bank.
They use it to pay off their credit cards and other debts.
This is one of the biggest mistakes that people make.
Your home equity should be used only for things related to your home, such as home improvement projects, renovations, or if you need to relocate for work.
You should never use your home equity to pay off your credit cards or other personal loans.
If you use your home equity to pay off your debt, you can affect your credit score in a very bad way. For example, if you have a FICO score of 700 and you use $100,000 of your home equity to pay off your debt, this will lower your score by 100 points.
Paying off your debt with your home equity will also affect your debt-to-income ratio.
If you take out a $100,000 home equity line of credit and use it to pay off your credit cards, this will increase your debt-to-income ratio.
This can prevent you from qualifying for future mortgages, auto loans, or other personal loans.
This is one of the reasons why you should only use your home equity for home-related expenses.
Borrowing Against Your Home Equity to Borrow More Money
Most people think that they can borrow against their home equity line of credit, and then take out a second or third loan to pay off their debt. This is not a great idea and could cause you to get in over your head.
For example, let’s assume that you have a $20,000 balance on your credit card with an interest rate of 20%. If you decide to use $10,000 of your home equity to pay off your credit card, you will end up owing $30,000. Let’s also assume that the interest rate on your home equity loan is 10%.
If you take out a second loan of $20,000, your total debt will be $50,000. This is a good way to get yourself into trouble.
In order to pay off your credit card and home equity loan, you will have to make payments of $1,400 per month. This is more than most people can afford to pay.
Should You Use Your Home Equity?
There are many reasons why it makes sense to use your home equity line of credit to make improvements to your home. Some of the most common reasons include:
• Paying for college expenses for your children or grandchildren.
• Investing in home improvements to increase the value of your home.
• Covering the costs of a medical emergency.
Getting out of debt by consolidating your credit card payments If you use your home equity to make improvements, you will probably see an increase in your property’s value.
This is a good idea if you plan on selling your home in the near future.
However, if you use your home equity to pay off credit card debt or other loans, you will probably lose money.
This is because of the fees associated with home equity loans and the high interest rates attached to credit cards.
In the example above, you would lose over $1,000 by using your home equity to pay off your credit cards and home equity loan. You would also be paying for a new roof, new windows, and a new hot water heater.
Even if you have a high credit score, you will most likely receive a lower interest rate on your credit card.
This is because the interest rates on home equity loans are usually much higher than the interest rates on credit card debt.
Home Equity Loans Are Not a Good Idea for Paying Off Credit Card Debt
If you need money to pay off credit card debt, a home equity loan is not the best option. The interest rates on home equity loans are high and the fees associated with the loan are even higher.
Instead, focus on paying off your credit card debt through a debt consolidation loan or a balance transfer credit card. These methods will save you money.
Your home is an investment, but it shouldn’t be your only investment. Keep your investments diversified and only use your home equity as a last resort.
1.2. Home Equity Loan Is not a free money!
You still have to pay the home equity loan back, and will do so with higher interest rate than you would on a credit card.
Home Equity Loans Are Not Your Average Mortgage
While the interest rate is lower on a home equity loan, the fees are higher. For example, your home equity loan may have an origination fee of 2% and an annual fee of 1%.
These fees along with your interest rate will quickly add up to more than you would pay on a traditional mortgage. You can avoid these fees by refinancing your mortgage instead of taking out a home equity loan.
Home Equity Loans Are Not for Everyone
Home equity loans are not for everyone. If you are having trouble paying off your credit card debt and want to take the easy way out, you should reconsider. Taking out a home equity loan is not the answer to your financial problems.
You could end up in a worse financial situation if you can’t make the monthly payments on your home equity loan. Just because you have the equity in your home doesn’t mean you should use it. Keep your home equity in a safe place, and only use it when necessary.
Home Equity Loans Are Not a Cure-all
Many people think they can use their home equity loan to solve their money problems, but that’s not always the case. If you are considering a home equity loan, make sure you are getting an interest rate that is competitive.
If your credit is excellent, you may be able to get a lower interest rate than someone with poor credit.
However, keep in mind that high interest rates will cost you more money in the long run. If you have an excellent credit score, you may be able to get a lower interest rate on a home equity loan than what you are paying on your credit card.
This can save you some money if you use the home equity loan to pay off your credit card balance.
Find a Good Loan Officer to help you find the best home equity
You may also want to find a good loan officer to help you find the best home equity loan for your needs. A good loan officer can help you understand everything that is involved with taking out a home equity loan and whether this is the best solution for your financial situation.
A good loan officer can help you determine how much money you can borrow, what the interest rate will be and if this is the best option for paying off your debt.
A good loan officer will also help you find a loan that fits into your budget and keep you from taking on more debt than you can handle.
If you need a loan to pay off your credit card balance, contact a loan officer today to learn more about obtaining a home equity loan.
The CFPB has published a great guide entitled the Home Equity Loan Checklist. This guide will give you a better understanding of what to look for and consider when shopping for a home equity loan.
1.3. Risk for the loss of your home.
Your home can be taken from you if you don’t repay the loan.
Some loans may require you to pay closing costs which can be expensive.
If you’re unable to make payments, you may lose your home. If you’re thinking about taking out a home equity loan, here are some things to consider:
The interest rate on a home equity loan may be lower than on a credit card or other type of loan, although it’s important to compare the rates you qualify for.
If you take out a home equity loan, your home is at risk if you can’t or don’t pay off the loan.
Your credit rating, income, and monthly expenses are all factors home lenders consider when deciding whether to lend you money and how much they will lend you.
If you can’t pay off the loan, the lender may foreclose on your home.
Also, if you want to refinance your home equity loan, you may need to pay additional fees. When you take out a home equity loan, you may be able to borrow up to 90 percent of the value of your home. You should be aware that if your home loses value or becomes hard to sell, you may have trouble getting another loan for as much money.
A home equity loan can be an important tool to help you pay for home improvements, emergencies, or other important expenses.
However, because your home is at risk, it’s important to understand this type of loan and how it works before you sign on the dotted line.
Home equity loans allow you to borrow money using your home as collateral. Interest rates tend to be lower than credit card rates.
Some people use a home equity loan to consolidate high-interest debt such as credit cards. Others use the money for large purchases such as appliances, furniture, or vacations. You can borrow up to the amount of your home’s equity.
For example, if you have a $50,000 mortgage on your home and it is worth $100,000, you have $50,000 worth of equity.
If you’d like to borrow money based on the value of your home’s equity, you can apply for a home equity loan or a home equity line of credit (HELOC).
A HELOC is a lower-cost way to borrow money than a home equity loan. You can also get a HELOC in addition to a home equity loan.
Home Equity Loan vs. Home Equity Line of Credit
A home equity loan and a HELOC are both loans secured by your house.
That means if you can’t or don’t pay back the loan, the lender can foreclose on your house and sell it to get the money you owe.
A home equity loan is a lump sum you get all at once.
A HELOC is an open-ended loan where you can borrow and repay money over time.
The main difference between a home equity loan and a HELOC is that with a home equity loan, the interest rate does not change throughout the life of the loan.
With a HELOC, you pay a lower interest rate for the draw period, which is usually about 10 years.
After the draw period, the interest rate on the remaining balance increases to a fixed or variable interest rate for the remaining life of the loan.
Home Equity Loan vs. HELOC: Advantages and Disadvantages
A home equity loan and a HELOC may offer you different advantages and disadvantages.
Home Equity Loan Advantages
A home equity loan can be a lump sum or a line of credit that allows you to spend the money on almost anything: paying off credit card debt, investing in your retirement, building an addition to your house, etc.
You are only responsible for repaying the loan if you own your house free and clear.
If you don’t, then you’re responsible for paying back the loan plus interest.
Home Equity Loan Disadvantages
A home equity loan is usually more expensive than a HELOC because with a HELOC, you only pay interest on the money you draw. You are not responsible for paying back the entire loan if you don’t own your home free and clear.
Home Equity Line of Credit Advantages
Interest rates are usually lower on a HELOC than a home equity loan because you only pay interest on the money you borrow. With a home equity loan, you’re required to pay back the entire loan regardless of how much you draw.
Home Equity Line of Credit Disadvantages
A HELOC requires a repayment plan, which is usually a monthly payment. If you are late on payments, the interest rate on your loan will typically adjust upward.
Because it is more difficult to qualify for a HELOC than a home equity loan, due to stricter lending requirements, you may have to provide more documentation that your interest rate will be lower on a HELOC than a home equity loan.
It is important to understand the difference between these two types of home loans so you can determine which one is better for your specific needs.