Home equity loan is good choice for debt consolidation; is it the best?

The current high prices of real estate have left many Americans with astonishing amounts of equity in their houses. Despite the fact that most mortgages offered today are either variable rate or interest only, Americans have seen their equity increase simply by watching the prices of houses in their neighborhoods go up. And as the prices have gone up, so have homeowners’ attempts to borrow against their newly acquired “value” in their homes. In fact, home equity lending will exceed a quarter of a trillion dollars this year.

As we have outlined before, consumers are using these loans to fund all kinds of things - boats, cars, education expenses, more real estate, vacations and many other things, including debt consolidation. Debt consolidation, the practice of combining debt from several sources into a unified loan at a lower interest rate, remains a popular choice for people taking out a second mortgage. On the surface, it would seem to be a good choice, offering lower rates than credit cards and featuring the somewhat overrated income tax deduction. 

But is it the best choice? Are other options equally good or even better for those with problem debt?

There are costs associated with taking out a consolidation loans through a home equity loan or line of credit. There are closing costs and appraisal costs and other incidental fees that must be considered. While these costs will probably pale next to the sometimes sky high interest rates and fees charged by credit card companies, they still exist and need to be paid if you go that route. Plus, not all lending is equal, and interest rates are higher in some parts of the country than in others. 

Here are some other alternatives:

• Budget your expenses and see where your money is going. If you find out that you’re spending $200 a month on a latte and a muffin at Starbucks, you might be able to cut that out of your diet and use the money on your bills instead. This is certainly a cheaper option than taking out a loan. Examine your expenses carefully and cut out everything that isn’t essential. You may save enough each month to put a huge dent in your bills.
• Balance transfer. Credit card loans are rarely cheap, but sometimes credit card companies will offer temporary loans of less than 5% if you transfer your balance from your existing account. If you can do this, great, but be careful.  If you transfer a balance to the new account, don’t use the card for any other purchases. They’ll be charged a higher rate and you will have to pay off the lower interest balance first while the new purchases accrue interest. And don’t pay late. That often revokes the low interest rate.

It’s always best to try to repay debts without having to borrow more money. Borrowing money against your house to repay debts adds additional risk. What if you can’t repay? You might find yourself without a place to live. Before taking out a debt consolidation loan, make sure that you actually need one. If you can pay off your debts without one, you’re better off.