April 24, 2019
The idea of going into debt to pay off other debts is not immediately intuitive, but it can actually be a useful tool to free you from bad debts. First, let's clear up the difference between a home equity loan and a home equity line of credit:
Home Equity Loan: This is similar to a second mortgage in that it is a single, lump sum loan that uses your home's equity (that is, its market value) as collateral. Home equity loans have a fixed interest rate and term.
Home Equity Line of Credit (HELOC): This is slightly more complicated in that a HELOC is a line of credit that draws from your equity. It's sort of like a credit card except your payments are taken from your home's value. Although a more involved process, HELOCs have the advantage of letting you choose the precise timing and amount you are drawing from the home, but they have more variable interest rates.
Using Home Equity to Reduce Your Debt
The reason home equity loans and HELOCs can be considered good forms of debt is because they have low interest rates. This is in part due to the fact that they draw on a more readily apparent source of collateral (your home's equity) than, say, a credit card. As a result, you can use home equity loans as a way to pay off bad debts and bills that would require higher payments otherwise.
Using equity to pay off your bad debt is a relatively straightforward process, but one that has a few steps:
Calculate your total debt
This should be a no-brainer—it's hard to pay off a debt if you don't know how much it is. Pay special attention to interest rates since some types of debt can actually have lower interest rates than a home equity loan.
Check your equity amount
Equity is more or less fair market value minus whatever amount you have left on your mortgage. Since this depends on your home having an accurate value assessment, your lenders may advise (or require) you to get it appraised as part of the approval process.
Calculate the amount of the loan
This is normally done by the lender and is usually based on a "loan-to-value ratio." Basically, the amount of the loan is going to be a percentage of your home's equity—often anywhere from 80%-90%. The result is going to be used as the cap on your loan amount or line of credit.
Take out the loan or HELOC
The option that works best for you is going to depend on a mix of your financial situation, the size or nature of your debts, and any other plans you may have for the money. Speaking with a financial advisor or credit agent who is more familiar with your circumstances can help narrow the options down.
Pay off your debt!
Enjoy the benefits and peace of mind that comes with being free of bad debt!
Borrow for Something Special
Equity can give you a great deal of freedom to borrow for other projects. You can use your home's equity to pay for vacations or to fund an otherwise unaffordable home or car repairs. Another option is to use your home's equity as a form of good debt to get something that can improve the value of your home, like renovations; it can also serve as a nest egg for later, like an investment property. Talking to a credit advisor can help you better understand ways in which credit can be used to grow your finances.
A Local Source for Western Mass. Home Equity Loans
LUSO Federal Credit Union is a member-owned, not-for-profit financial cooperative dedicated to providing its members with quality financial services and products. We at LUSO pride ourselves on serving the financial needs of those who live, work, worship, do business, or attend school throughout Western Massachusetts, regardless of economic status.
Feel free to contact our Ludlow branch toll free at 1-844-LUSO-FCU or our Wilbraham branch at 1-800-808-5876.