Posts Tagged ‘Collateral’

Using your home for debt consolidation

Ever wonder how debt consolidation works? Should you use your home as collateral to consolidate debt? With the rising costs of everyday life many Americans are looking for ways to lower debt and reduce their monthly expenditures. Many people are turning to professional help such as debt consolidation loans. One of the most popular ways to consolidate debt is using your home as collateral for the loan, but is this a good idea?

With the growing number of television, Internet and newspaper advertisements for debt consolidation loans it may seem very tempting. Debt consolidation companies promise to lower your monthly payments or even eliminate your debt all together. Again it sounds very tempting, but you should be aware of exactly what is going on behind the scenes.

When you contact a debt consolidation company the will usually ask you a series of questions concerning your home. The will want to know how much your home is worth and how much you owe on your home in order to find out how much equity you have in your home. The reason they want to know this is because they are planning on turning all your unsecured debt into secured debt by using your home as collateral.

Using your home as collateral will usually lower your interest rates considerably and in turn lower your monthly payment, but there are some serious concerns to consider. First, if you find yourself in more financial trouble in the future and can’t make the new consolidated payment you will be at risk of losing your home to foreclosure, in turn making your credit and life much worse.

The second thing to consider is that most of us spend as much money as we have every month. Freeing up extra dollars per month after debt consolidation means we have more money every month to spend on other things, things we don’t really need. This in turn causes the debt process to start all over again and you will be in much worse shape than you were before you started the debt consolidation process.

There are some instances where debt consolidation can be very helpful, but you must be a disciplined person willing to make financial sacrifices in order to better your situation. Also make sure the debt consolidation company has your best interests in mind and not their own financial gain. Do some research on any company before you give them any personal information.

HELOC or Home Equity Line of Credit

A home equity line of credit or HELOC as it is commonly referred to is simply what it says. It’s basically a line of credit similar to a credit card which allows you to use your home as collateral. This gives you a better interest rate on the loan than a credit card, but puts your house as risk instead of just your credit score.

Usually HELOC’s are taken as second mortgages on your primary residence. At the time of closing the lender sets a specific credit limit on the loan based on the equity you have in the home. For example if your home is valued at $200,000 and you currently have a mortgage of $150,000 on the home you have about $50,000 equity in your home. Many lenders will let you borrow up to 95% of the value of the home so your line of credit may be as much as $47,500.

Once the HELOC is established you can usually write checks from the account, use a special type of card similar to a debit or credit card, or other methods to withdraw money from the credit account.

The interest rate on a HELOC is a variable rate and the terms of the loan are established at the time of closing. Terms can be extended as much as 30 years so payments on the loan are lower.

An alternative to a HELOC is a simple second mortgage which is the same pricipal except you get the money in a lump sum. The interest rates can be variable or fixed and terms can be about the same as a HELOC.

As with any type of loan there are advantages and disadvantages. The advantages of a HELOC is the flexibility of having extra money avaliable at a moments notice with a lower interest rate than a cash advance on a credit card. You only have to withdraw the exact amount from the account, thus paying interest  only on the amount you borrow. Also closing costs or up front costs are usually much lower than a second mortgage.

There are of course disadvantages or risks involved with a HELOC. Disadvantages of a home equity line of credit include rising interest rates from month to month. Since the interest floats or is variable it can increase a certain amount each month causing your payments to inflate each month. There are very large caps on the interest rates on a HELOC. Most max out at or above 18%!