Consolidating Debt using a Home Equity Line of Credit
From time to time we all accumulate debts of different types, and one of the best uses for a home equity line of credit is to consolidate high interest debts into a lower form of debt. Heloc's offer a unique ability to not only wrap up other debts into a single loan, but also to reduce the overall amount of interest you're being charged as well as having the flexibility to repay those debts much faster. The end results is that if used correctly, a HELOC can let you take the same payments you were making, and pay those debts off a lot faster. Secured vs Unsecured Debt Most types of flexible and readily available credit, particularly credit cards, are unsecured debts. This means that the debt you accumulate are not secured against a specific asset that you own. |
Refinance Rates
Purchase Rates
Refinance Rates,
Refinance Rates
Purchase Rates
Purchase Rates,
| As a result, if you don't pay your bills, the lender cannot point to a
specific asset you own and sell it out from under you to recover the
debt. They can still enforce collection action against you, but it's
harder to get their money back, especially if there are other creditors
also chasing you for payment! Unsecured debts are alsways paid out last in the event of a bankruptcy, and these factor combined mean that unsecured debts are charged at a much higher rate of interest than other types of debts are. Sercured Debts however are very different. A secured debt gives the lender a direct claim to ownership of something you own (the security) should you be unable to repay your debts. This gives the lender greater security, and as a result, secured loans are charged less interest. A Home Equity Line of Credit, like a cash out refinance or equity loan, is a secured loan (and hence attracts lower interest rates than unsecured loans) that has the flexibility of a credit card. By using a Line of credit to pay off your other, unsecured debts, you are effectively shifting the debt from unsecured (high interest) to secured (lower interest). |
Repaying HELOC's
Heloc loans offer flexible repayments, which can be another advantage over personal loans which may have a fixed repayment amount and term. This allows you to do one of two things:
1. Pay the debt off faster, by using any available cash that comes up - or creating a reverse debt "snowball" (more on this later).
2. Keep your repayments to a minimum if you need the cash flow, and pay it off more aggressively later when the opportunity presents.
The flexibility of a Heloc cannot be overstated - it is the single biggest advantage of this type of loan. An unsecured personal loan taken out witha 5 year repayment term will accumulate a high amount of interest over that 5 years. If you are able to pay less interest by shifting it to a heloc, and pay that heloc off aggressively as the opportunity come up, you will find yourself debt free a lot more quickly.
The Debt "Snowball"
You've probably heard people talk about their debts "snowballing" or spiraling out of control. you miss a payment, get penalites added to the debt, the repayment amount goes up and your credit score goes down. Do this a couple of times and it can quickly get out of hand. Soon enough your minimum repayments are too high to afford and you start falling further and further behind.
The good news is that you can also create a Reverse Snowball effect as well, and this is easy to do with a Home Equity Line of Credit. Lets say that you currently have a credit card with $10,000 and an unsecured personal loan of $5000 - your current monthly repayments are $250 per month which you are struggling with, but are just keep ing up. You then take out a HELOC, secured against your home, and use it to pay off the card and unsecured loan. you now have a HELOC of $15000 and no credit card debt or unsecured loan. Becuase the Heloc has a lower interest rate than the other loans did, your minimum repayment is only $150 per month instead. Rather than spending the extra $100 per month you now have though, you keep making repayments of $250. After a couple of months of this the Heloc's balance outstanding has gone down and your interest cost are now only $130 per month instead. You continue paying $250/month and very quickly the principal debt gets cut down, in turn dropping your interest charges. Now it is your savings that are snowballing instead of your debts, and you credit score rises rather than falls. Whereas previously you were struggling to keep up with your payments before, in a few short months you've created breathing room andina few more you can comfortably reduce the repayments to a more comfortable level while still getting debt free much faster.
Flexible repayment terms, combined with lower interest rates are an ideal 1-2 punch for knocking out debt, without paying even a cent more.
Tax Deductibility
One other advantage of a Heloc for debt consolidation is the fact that debts secured against a home are tax decustible (the first 100K at least for a married couple), while unsecured debts or debts secured against vehicles and the like are not - this is something to discuss with your advisor or accountant, but is an additional benefit to be considered.
The Bottom Line
The end result of all this is that if you have unsecured or high interest debts, and have the opportunity to consolidate it into a heloc, it's almost always a good idea to do so. Lower interest, flexbile repayments and tax deductibility add up to a winning combination for consolidating debts.
