Taking Out a Debt Consolidation Home Loan - Risky Business?

Taking out a home equity loan to consolidate and pay off some of your existing debts seems like a good idea. After all, with mortgage rates around 6%, and credit card rates around 18%, you could save a lot on interest payments. But contrary to popular wisdom, using home equity to pay off high-interest debt is not always a good idea - after all, it could cost you your house.

Interest Rates and Minimum Payments

Under new minimum payment rules imposed by the major credit card providers, your minimum monthly payment is at least 4% of your balance. If you carry $10,000 in credit card debt, this means that your minimum monthly payment will be $400. A five-year home equity loan at 6% interest would have a monthly payment of just $193 - so you would be saving more than $200 a month. Or would you?

First consider the fees generally associated with home equity loans, which could easily bump your effective interest rate up by a percentage point. Then consider that you might not qualify for the 6% mortgage rate, but an 8% home-equity rate, especially as interest rates are on the rise. With an effective 9% rate, your home equity payments would be about $14 more ($207) per month - still not a big deal, right? Well consider what happens if - for whatever reason - you are unable to pay back your loan.

The Difference Between Secured and Unsecured

Let's say something bad happens and you're unable to keep up with your payments. If you default on your credit card, the worst thing that is likely to happen to you is a "charge off" on your credit report. This will be damaging to your credit for as long as seven years, and when (if) you pay it off, it will still be a black mark on your credit report. But compared to what happens if you default on your home equity loan, a charge-off is a slap on the wrist.

Credit card debt is unsecured. If you're unable to pay it, you are allowed to walk away essentially unscathed, other than a little damage to your credit report. But nothing, not even bankruptcy, can get rid of a secured debt like a home equity loan - a debt which is secured by your home. In other words, considering that most people seek out debt consolidation help after they're already in trouble, you may be greatly increasing your risk by attaching your home to your outstanding debts.

This, of course, does not mean that debt consolidation home loans are always a bad idea. The significant savings on monthly payments that they can provide can sometimes justify their added risk. Also, consider this: By making the minimum payments of $400 on $10,000 in credit card debt, it would take you almost 15 years to pay it all off, during which time you would pay a total of almost $6,000 in interest (assuming an 18% interest rate). With a home equity loan at an effective 9% (including fees), you would pay off the $10,000 in just five years, and pay less than $2,500 in interest. That's quite a difference!

Invest In Your #1 Asset - Yourself!

The scary thing is how many people make major financial decisions without being fully informed. Billions of dollars are forfeited every year by people who could have saved money if they only had invested in their #1 asset - their financial education. Browse Debt Relief USA to learn all that you can about the various options available to you, and then consider visiting with a credit counselor or financial planner to help you develop an appropriate strategy to deal with your debts. You've made it this far, so you obviously have the initiative to take action. Don't give up!

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Please Note: Unsecured debts are debts such as credit cards, personal loans, lines of credit, store cards, medical bills, and utility bills that are not secured by collateral. Mortgages and car loans are NOT considered unsecured debt.
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