Is HELOC a Good Source for Debt Consolidation Funds?
Many people use HELOC for debt consolidation because of its lower interest rates and the fact that it is a tax-deductible loan. However, using Heloc for debt consolidation funds needs a lot of careful analysis because there are many factors to consider. When used unwisely, using a HELOC as a source for debt consolidation funds can easily produce worse headaches than the ones you were trying to avoid by consolidating your debts in the first place.
What is a HELOC?
HELOC stands for Home Equity Line Of Credit. You can use this line of credit for consolidating your debts because it often has lower rates than your other loans (specially credit card debts). It is also a tax-deductible loan. This is one of its main appeals. Unlike regular loans, you can deduct a part of your HELOC payment from your taxes. Ideally, you should use a HELOC like using lower interest rate cash advances from a credit card to pay off higher interest loans. You take out the LOC and use it to pay your other debts and zero the amount. You’ve effectively transferred your existing debts and consolidated various higher interested rates into one loan and one rate.
What to consider when using Heloc for debt consolidation
Consider the total balance of the loan and interest rates. The total balance of your LOC depends on the amount of equity you have in your home. During recessions, home values sometimes decrease dramatically and many homeowners find themselves with little to no equity. What’s worse, many homeowners are actually “upside down” or “underwater” with their home loans–the value of the loan is higher than the market value of the home. Often, local foreclosures’ impact on home values push these homeowners even deeper under water. So the first in considering HELOC financing is to make sure that you have equity in your home and if it’s enough to borrow against. Banks will only lend up to a certain percentage of the equity value of your home. This varies from bank to bank, but expect some discounting from the equity value. A related note, make sure that the equity values in your area are stable before even trying to apply. Volatile or rapidly sliding local values mean your application might have a high chance of rejection.
Consider your personal commitment to repayment. You must commit to self-discipline when consolidation your loans using HELOC. If you are not disciplined and careful, you will merely create new loans and end up at the same place you were before HELOC consolidation — under a mountain of uncontrolled debt. A little self-discipline goes a long way. Also, just like a credit card cash advance, make sure you commit to pay off the HELOC on a timely basis. It would probably be a good idea to cut up some unwanted credit cards once you have consolidated your debts.
Consider the risk of foreclosure. HELOC consolidation does not mean debt elimination. You merely move one pile of debt with higher interest rates to another pile that has one lower interest rate. The tax-deduction is a welcome bonus. You must still pay for this loan. Just like any home-based loan, ff you default your house is at risk of foreclosure. Again, the HELOC is not a “Get out of Debt Jail” card. It is backed by your greatest asset–your home.
Alternative sources for debt consolidation funds
You don’t necessarily have to use an HELOC to consolidate your debts. There are other options. The HELOC is primarily attractive because of its tax-deductible features and its usually lower interest rates. There are other methods for consolidating your debt;
Cash out refinancing is an alternative because it involves paying off your current home loan and getting a bigger loan. Again, this alternative’s availability depends on how much, if any, equity your home has. You can use the difference in the cash out refinancing loan to consolidate your loans.
Use a regular home equity loan. Another alternative is to use a standard home equity loan, unlike the HELOC there’s no tax advantages and interest rates can vary from provider to provider. Depending on prevailing mortgage rates, the interest rates might be to your advantage so this option cannot be entirely disregarded. All of the alternatives above assume that you have equity in your house. No equity means no refinancing, which means no debt consolidation.
Many people use HELOC for debt consolidation but this type of loan may not be a wise choice depending on your situation. There are other better alternatives consumers can take advantage of when looking for debt consolidation funds.
Sources
http://www.pcbs.org/government-warns-banks-heloc-reductions-must-comply-with-federal-law/
http://www.lendingtree.com/debt-consolidation/advice/getting-out-of-debt/choosing-debt-consolidation-loan/
http://moneycentral.msn.com/content/Savinganddebt/Managedebt/P36230.asp