Home Equity Debt Consolidation: Benefits, Risks & How It Works

Opting for home equity debt consolidation can provide you with a viable solution to reduce both your monthly payments and your principal debt. Debt consolidation is complicated, and using the equity you have in your home to secure the loan can increase this complication. Only opt for this route if the benefits of a home equity debt consolidation outweigh the risks in your case. 

Lower Interest Rates

Secured loans use collateral to reduce the risk incurred by the lender. With a home equity loan, you are pledging a certain amount of ownership in your home to the lender if you default. This means the lender can be assured it will not actually lose money if you fail to repay the debt. Lowering the risk to a lender will always result in a lower interest rate on the loan option. This can save you thousands of dollars over opting for a debt consolidation loan without any collateral. 

Lower Credit Requirements

One challenge to consolidation your debt may be your compromised financial profile. As your debt gets out of hand, your credit score drops, and you become a less desirable client for a lender. Consolidation will only be a solution if you can first find a loan large enough to pay off your existing debts. Getting a loan in your compromised state will not be easy, but using collateral can make it easier. You will not only find lower interest rates on a loan if you use collateral, you will also have an easier time finding loans in the first place. When you approach a lender, you will only be asking for a sum of cash in exchange for an asset instead of the extension of credit with no promise of repayment.

Financial Penalties

All debt modification carries the risk of financial penalties. For example, a lender can charge you a fee to pay down your debts early. Similarly, a lender can report you to a credit bureau for settling a debt. When you consolidate your debts, you are settling multiple loans at once, meaning you can see an exponential amount of harm to your existing credit score. The goal is to reduce your total debt, but if your settlements are not sufficient to cover fees and penalties assessed by your lenders, you may even end up increasing your debt instead of reducing what you owe. 

Risk of Losing Collateral

Borrowers often think they cannot lose their home if their mortgage is in good standing. A home equity loan is a subordinate debt on the home which means it is second in line to a mortgage. However, you can still lose your home if you default. Your home equity lender has the option of purchasing your mortgage from your mortgage lender. If this occurs, the equity lender can force your home into foreclosure with the lien from the home equity loan. You may have all of your mortgage payments current for the entire length of your loan and still lose your home if this scenario does occur.