Home-Equity Loans
Home-equity loans are, as the name suggests, loans against the equity you have in your home. They allow you to borrow fairly large amounts, and the interest rate is typically more attractive than what you can find on a credit card. Why do they let you get a really big loan at a really low interest rate? Because you're putting your home up for collateral. This is a low-risk loan for the bank. They know they can sell your house and collect their money if necessary. Therefore, you'll probably make that debt a priority, and pay as agreed, if your home is on the line. This type of loan can result in debt elimination, or a complete disaster.
Debt Consolidation
Some borrowers use home-equity loans as part of a debt-consolidation program. For example, you can get a large home-equity loan and use the proceeds to pay off several smaller debts. This can sometimes work out nicely.
Home-equity loans can have expenses that take away some of your savings. You might have to pay closing costs, appraisal fees, and more. Make sure you know all of the costs in detail. Then, run the numbers and see if it's worth your trouble, and the extra risk of putting your home on the line.
Let's assume you have several large credit card debts, and you're paying a high interest rate on all. You could transfer the balance to other credit cards, but you decide not to for reasons we've discussed in this chapter. Instead, you might take a home-equity loan and pay those debts off. By replacing several unfavorable loans with one loan, you can simplify your life. Furthermore, you'll probably reduce your borrowing costs — the home-equity loan should have a lower interest rate than the rates on your other debts. To add to your savings, you might get a tax deduction for the interest you pay on the home-equity loan. This is starting to sound good, right?
Pitfalls of Home-Equity Loans
While they make sense in some situations, home-equity loans can hurt you. As with playing the balance-transfer game, you don't really eliminate any debt when you perform debt consolidation with a home-equity loan. Also, you get into big trouble if you can't make payments for some reason. Life is full of unknowns, and it's all too common that a sickness or tragedy gets borrowers off track. If you're going to miss payments or default on a loan, it's much better to default on an unsecured loan like a credit card than on a loan secured by your home.
