The purpose of a debt consolidation loan is to combine your other debts that are forcing you to pay high interest rates. The strategy typically is to consolidate these debts through a personal asset such as a home equity loan that comes with a low interest rates, which means financial benefits for the borrower and less risk for the lender.
Debt consolidation can be a great way for people to get out of debt. An advantage of a debt consolidation loan can be that it is usually tax deductible if you use a home equity loan or line of credit. In addition it is easier in a very logical sense in that you have one debt to maintain rather than multiple credit card balances to manage.
A great option in many cases is to use your home equity. The equity is the part of your home that you actually own. You can either pay through principal or pay through appreciation of your home. Be careful though because sometimes home values may be tricky depending on the current financial environment for a given time and place. When you sell your home the equity is the cash you get and by getting a home equity loan you essentially get that cash while you live in your home.
A home equity loan is like a first mortgage where you get a lump sum and interest and principal payment combine to pay the loan in a determined amount of time.
A home equity line of credit is another popular option. This allows you to access needed money through a credit card, checkbook or debit card related to that loan. HELOCs have adjustable interest rates and you pay interest only on the amount you withdraw instead of the credit limit in its entirety. A line of credit is usually for 10 or 20 years and then after there is a fixed period to pay off the rest of a loan and interest.
Generally speaking though, home equity loans are easier to budget and they come with a fixed interest rate. Just be careful because when you take this loan you are lower the equity of your home until the debt is paid. So if you bought your home for $220,000 and sell it for $300,000 than you look to have an equity of $80,000 at closing. Well, if you have a home equity loan of $20,000 than the difference leaves you with $60,000 until the debt is paid.
The thing to be very cautious of is the possibility that value of your home won’t continue to rise. Don’t rely on inflation of home values when planning for the future because if you default on your debt consolidation loan you can lose your house.
