The benefits of using home equity extend far beyond simple home improvements. You can use home equity to pay for school tuition, fund a family vacation, or start your own business. Many also use home equity funds to consolidate bills. But are there drawbacks that outweigh the benefits of consolidating debt with home equity?
In this blog, we'll explore how to wisely use a home equity line of credit to combine and pay off debts, as well as some of the risks you should look out for and avoid.
A Home Equity Line of Credit, commonly called a HELOC, is a line of credit where your home serves as the collateral for your borrowed funds. You will be approved to borrow a certain amount of money from your borrower as determined by the portion of your home that you own, or your equity. Since the home serves as the collateral, the financial institution can take your home if you cannot pay back what you owe.
HELOCs are a line of credit, and they operate similarly to a credit card. You'll pay back the money you borrow (plus interest), and in doing so, the funds will return and become available to you once again. HELOCs are popular since you don't need to borrow the money all in one lump sum at one time like you would with a traditional loan.
You can use a HELOC in a variety of ways. You may consider applying for one to fund a dream vacation, to go back to school, or to kickstart your own business. However, many turn to HELOCs as a solution for debt consolidation. If you have multiple monthly payments, combining those obligations into one payment may be a solution you want to explore. This is known as debt consolidation.
If you have multiple balances on credit cards, personal loans, and more, a HELOC may be a solution you can turn to if you're seeking to combine these debts into a line of credit with one monthly payment. This solution can provide peace of mind and help you avoid needing to make several payments for different loans and cards month after month.
There are several positives when it comes to using a HELOC for debt consolidation. Some of the most common include:
Improving your credit score over time: While applying for a HELOC will likely negatively impact your credit score at the start, consolidating your debt is a good strategy in the long run. As long as you continue to borrow responsibly and pay off your debts, your credit score should improve over time.
If you look to use your HELOC funds down the line as you pay off your debts, there could be potential tax deductions depending on how you use the funds. You may be eligible for these deductions if you use your HELOC to complete major home renovations or improvements. You can learn more about HELOCs and tax deductions here.
Using a HELOC for debt consolidation isn't always a foolproof strategy. There could be some potential drawbacks, and these may include:
Closing costs and fees: You’ll most likely need to pay some fees when applying for a HELOC, just as you would with a mortgage. These are known as closing costs, which include appraisal fees, origination fees, and any other charges needed to open the line of credit. Closing costs often amount to 2-6% of the total amount.
If your primary goal is to trim down your debt and get ahead, a HELOC isn't the only solution you should consider. There are alternatives that can still help you achieve what you're hoping for. These include:
Home Equity Loan: While a home equity loan and a HELOC are similar, they aren't the same. Your home is still the collateral with a home equity loan, but you'll receive all the funds you need up front once approved.
If you think one of these alternatives may be for you, we have these solutions here at American Heritage. Our Platinum Preferred Mastercard comes with an introductory 0% APR1 on balance transfers for the first 9 months, and a 9.99% APR1 thereafter. We also offer personal loans with low rates and fixed terms, as well as home equity loans.
There are a variety of ways to tackle your debt consolidation strategy, and none are one-size-fits-all. Recognizing you want to trim down your debt is the first step to achieving financial freedom.
If you’re still on the fence if a HELOC is the right solution for consolidating your debt, you can learn more about their ins and outs, as well as how they work, here. When and if you do decide to apply, you’ll need to have a few documents handy, such as a valid government-issued ID, proof of residence, pay stubs, W-2 forms, and more.
1Introductory0.00% APR for purchases and balances for 9 months from credit card open date. Balances and purchases are subject to standard 9.99% APR thereafter. Approval for a Platinum Preferred Mastercard depends on creditworthiness and other qualifications. Other restrictions or conditions may apply. You may not pay off your current American Heritage Credit Union credit card, loans or lines of credit by using this balance transfer or cash advance options. Offer available to all new qualified Platinum Preferred Mastercard holders. Foreign transaction fees may apply. Existing Platinum Preferred Mastercard cardholders in good standing with no outstanding balance may be eligible for 0% APR depending upon current promotional enrollments. Existing Platinum Preferred Mastercard holders may visit a branch or contact us at 215.969.0777 to learn more. American Heritage reserves the right to refuse any balance transfer request. See account Terms and Conditions for information on fees, click here.