People who are in debt, especially those who are desperate enough to want to break free from it will stop at nothing to pay it off. They will go through lengths to give their finances one more chance and in some cases, will be willing to sacrifice a lot to make it happen. Even if that means using assets like their home to pay off their debt.
But before you consider using your home to consolidate debt, you need to make sure that it is the best option to get out of debt. While it is a legal way to get out of debt, you should not put your home on the line immediately. You have to understand the pros and cons of consolidating your debts against the value of the home that you are living in.
An article from MarketWatch.com revealed that in first 3 quarters of 2013, new home equity loans rose by 30.8%. This is compared to the same period in 2012. This means more and more people are borrowing money against the equity of their home. The report that originally came from Inside Mortgage Finance revealed that this is still lower than the pre-recession levels. While homeowners have every right to use their home to consolidate debt, it paints a financially desperate picture nevertheless. If you are willing to put your asset on the line for debt, that means your current income is not as stable as you would like it to be.
The analytics revealed that in 2014, this figure is expected to grow by 5% to 10%. This is because the housing rebound raises the equity of homes across the nation. That means homeowners can get a bigger amount in their loan.
Possible problems when using your home equity in debt consolidation
If you are among the expected 5%-10% growth, you need to seriously consider the pros and cons of debt consolidation – especially if you will put your home on the line for it. Starting with the negative, let us define the three important problems that could arise if you borrow money against your home’s equity.
You can lose your home.
There is always the chance that you will lose your home. In most cases, you consolidate your credit card debt with your existing mortgage loan. It will make your debt payments a lot more simple because you combine multiple accounts into one. But if your money starts to falter or you lose your job altogether, owing on your credit card will allow you to negotiate for a lower interest rate. Or you can negotiate for a debt reduction. This is not always possible with secured debts. When you consolidate debt through a home equity loan or home refinancing, you are converting your unsecured debt into a secured loan. If you cannot pay, it is more difficult to negotiate. The lender will have the upper hand because they merely have to get the home you put as collateral to recoup their losses. According to an article published on USNews.com, while this method of debt consolidation is reasonable, it is not the best way to get out of debt. It will seem like a good idea because of the low interest rate but you do not know what the future will be like. If you lose your job, the one asset that can help you rise out of it is already compromised by your other debts.
You could pay a higher interest amount.
And speaking of interest, a home loan is generally given with a low interest rate – that is true. However, you need to understand that you are also stretching your payment terms over a longer period. In most cases, even with a lower interest rate, you will still end up paying off a bigger interest rate. You are not really saving money here. You think you are saving because of the lower monthly contribution but that is not always true. If you compute it over the course of the whole term, this payment plan will end up costing you more.
You are merely treating the symptom.
The last problem with consolidating debt, just like the otr debt solutions, is the fact that you are not really treating the root cause of the problem. You are paying off the debt but that is just the symptom. You have to treat the illness that got you in debt. Is it a small income? Or is it excessive spending? Did you get yourself in debt because you failed to prepare for an emergency? That one unexpected expense prompted you to put yourself in debt. These are the root causes of debt that you need to work on. Do not focus too much on paying off the debt. Some people who make this mistake, especially when using debt consolidation, ended up accumulating more debt. When you consolidate debt, you end up with one payment every month and it is usually lower than what you used to contribute. This gives you the illusion that your debts are not as bad as you thought it was. When that happens, the temptation to put yourself in debt again will he harder to resist.
If you know that these pitfalls are something that you cannot avoid, then do not use your home as your way to consolidate debt. There are other options that will still solve your financial problem.
When is it okay to use your home in consolidating debts
There are instances when using your home in debt consolidation is a good idea. If you think that the following applies to you, then debt consolidation may be the best debt solution for you.
- You have enough equity in your home. If you have enough equity in your home to completely pay off all your multiple debts, then go ahead and put your home on the line. It is important that you consider just how much you will get out of your home’s equity. If it is not enough, then do not go through with it.
- You have the capabilities to pay it back. Another important sign that will tell you to go ahead with this plan is when you know that you have the income to pay it back. If you are confident that you can make a way to ensure that you home will not be taken from you, then consolidating your debts will not be a problem.
- You simply need to lower your monthly contributions. Some people can solve their debt problems with consolidation because they only need to have breathing space in their monthly budget. This debt solution can lower your monthly payments. But if you know that you need a debt reduction, then this is not the right program for you to use in debt relief.
- You have a back up payment plan in place. Before you commit to a loan, you have to be sure that you have a plan to pay it back. We already mentioned that. But this is going further than that. You need to make sure that your payment plan has a back up plan. CreditDonkey.com revealed in a survey that 50.8% of consumers in debt plan to be debt free in 5 years. If you do not have that confidence, then think twice before putting your home on the line for your debts.
We are not against the solution to consolidate debt. However, you need to think if consolidation is a good idea especially if you intend on using a home equity loan. A wrong decision might end up costing you more in the long run.