Loan consolidation
Ask a lender and he/she will present before you numerous benefits of using your home equity to consolidate your other loans, pay-off your credit card bills and purchasing big ticket items. Ask a financial advisor and he/she may tell you that using your home equity for the above mentioned purposes is an absolute no-no, almost suicidal. Then how to travel down a financially prudent path
To fully realize the implications of a home equity loan, you need to understand what a home equity loan is and what home equity is
By home equity, we refer to the difference between and the current appraised value of your home and the amount you owe on mortgage.
By taking a home equity loan, a home owner is using his/her home equity as collateral to borrow money.
Any asset that you pledge to the lender as a guarantee that you will repay the loan is called a collateral.
If you somehow failed to repay the home equity loan, lender will sell off the collateral, which in this case happens to be your home, to get the money.
Home Equity Loan scenario.
Yes, there can be no denying the fact that home equity loans are popular. After all a lot of people take these loans. But mostly home equity is used for some important objectives which include funding the childrens higher education, making alterations and renovations in your home or purchasing a second home. All these objectives appear much more important than getting rid of your credit card debt. And even for these purposes, some experts advise against taking home equity loans.
After all, you can get a college education loan to finance your childs education. The much-coveted home renovation, which according to your perception will add a lot of value to your home, may achieve precious little as far as value addition is concerned. The stylish kitchen cabinet may appear very valuable to you but the next buyer may dislike their design altogether. Similarly, a swimming pool ban in the middle of your home may appear absolute bliss to you, some other person may wonder which idiot designed a swimming pool in this part of the house.
To put it plain and simple, a home equity loan just do not match with some peoples thought process. Its because the asset you are putting on the line in a home equity loan is so critical that just by somehow defaulting in repayment, you may find yourself living in a corrugated box instead of your dream home.
Home equity and credit card debt.
Right now, we are concerned about deciding whether using home equity to pay-off credit card debt is a wise choice
The trouble with a credit card is that before you can realize, you can find yourself deep in credit card debt. To find out how this happened, you can go through your credit card statement as many times as you like, only to find that a few candle-light dinners here, some designer clothes there, a single weekend getaway, a few late charges and then the addition of a lot of interest, which your parents used to deduct from their taxes but that luxury is no longer available to you, and you are in credit card debt.
Points in favor of using home equity to pay-off credit card debt are they valid
Thus, its common to find people with more credit card debt than they can handle. When faced with such a situation, many people tend to view rolling this debt into a home equity loan as a great solution.
The first and foremost argument forwarded by the advocates of using home equity to pay off credit card debt is that the person concerned is already in debt with the credit card companies. Now if he/she refinances this debt into a home equity loan, there is no increase in debt. There is just a movement of debt but not a dime will be added to what the person already owes. Refinancing is simply a method to shift the debt from various credit cards to just one lender at a much lower interest rate and a fixed repayment plan. Thus, not only you will be getting the convenience of a consolidated payment and fixed payment dates, you will also get tax benefit, just like your parents used to get before 1987, writing off their credit card interest off their taxes.
Well, all this sounds good. After all, who doesnt want to pay a lot less interest, in addition to making this interest expense tax deductible Ah! This certainly appears an attractive option theoretically. In real world of course, the situation may take an entirely different turn.
Only a person who is in the habit of spending without proper financial planning will end up with a big credit card debt around her neck. To get rid of this debt, this fellow may use home equity option once. But will this change his/her spending habits Who is to guarantee that the person will not end up at the same spot after a period of time, and to make matters much worse, this time without the luxury of using home equity to get out of this spot It is very easy for a debtor to just blurt out an oath after taking a home equity loan that he/she will never carry a credit card balance again, but it is a Herculean task to change ones spending habits. Before long, the plastic will again start finding its way out of the wallet again frequently, and the debt cycle will cheerfully resume.
Oh yes! What about the reduced interest rate and savings from tax deductions
Again, how nice these things look on paper. The moment you start making a few very simple calculations, the scenario undergoes a drastic change. Take any figures you feel like, and do a few simple calculations yourself. Yes, a home equity loan will give you lower interest rate and therefore a lower monthly payment, but you will invariably end up PAYING MORE, not less, over the long run because these lower payments will be stretched over a LONGER time period. And since you will end up paying more money to the lender, this extra amount will cancel out the saving you will make through tax deductions!!
Long story short You can use your home equity once to get out of credit card debt, but since in all likelihood you will fail to change your spending habits, you will end up at the same place before long, in effect digging yourself deeper and deeper in a hole.
Secondly, fail to pay a credit card debt, and you can still keep living in your home. Fail to pay a home equity loan and find yourself out on the streets.
Thus, using home equity to pay off credit card debt is an option which you will be better off avoiding.
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