If you are motivated to pay off your high-interest credit cards or other debt, you’re not alone. Fortunately, there is a way to generate additional income to pay off your debt with something you already have–your home equity.
Because home equity loans are secured loans (credit cards are unsecured), they almost always offer much lower interest rates. This lower interest rate will lower your monthly minimum debt payments significantly.
In this article, we will discuss three ways to use your home equity to free yourself from debt.
Option #1: Refinance Your Mortgage Loan
Refinancing a mortgage loan is an excellent way to drastically reduce your monthly debt payment while slashing the often high-interest rates credit cards charge.
In 2018, the average interest rate of new credit card offers was 16.73%. Contrast that with the average 30-year fixed mortgage refinance rate, which was 4.52%.
There are several other factors to consider, including the additional length of the mortgage loan. However, you stand to cut your monthly debt payments by a sizeable amount instantly with this option.
You likely will not know the precise terms of your refinancing loan until you start applying. You can, however, estimate the benefit of refinancing based on:
- Approximate closing costs.
- Your home’s value.
- How your credit-worthiness will affect a change in the loan’s terms.
Many easily accessible mortgage refinance calculators will help you figure out when the savings will surpass the costs. This break-even point is one of the most important things to consider.
How it compares to how many years you plan on staying in your home is very important.
To calculate your break-even point, divide your total costs my month-over-month savings. The result equals the number of months required before the savings surpass your refinancing costs.
Option #2: Home Equity Loan
Ever since taking out your first credit card, you probably had dreams of owning your own home. Now that you do own your house, you can use its equity to pay off some of your high-interest cards, and other debt.
A home equity loan has an advantageous interest rate for the duration of the loan. It is a fixed interest rate, and you will have the opportunity to free up extra cash to pay off debt every month.
Other advantages include:
- Fewer upfront fees compared to refinancing the mortgage loan
- No paying extra to pay the loan off (no early pre-payment penalty)
- Tax deductible
Remember, because it is a secured loan, a home equity loan will almost always offer a much lower interest rate.
Interest on a mortgage is tax deductible. In general, you can claim interest paid on your home equity loan in the same manner you do on your original mortgage. Compare this to other loans, which include no tax advantages.
Thus, the more your mortgage interest is, the more you may deduct from your taxes. Therefore, this type of loan can be very advantageous when used to pay off high-interest loans. A car loan would be one example of this.
So that they are competitive with other kinds of loans, home equity loans present many advantages. For example, a home equity loan typically carries a fixed interest rate and a set monthly payment. This monthly payment never changes.
You can often choose the length of the loan term, which will lower or raise your monthly payment accordingly.
In some cases, lenders offer adjustable-rate home equity loans. With these, interest rates may go up or down, fluctuating your monthly payment. The fluctuation is dependent on the national prime interest rate.
So if you are interested in paying off your debt, why choose an adjustable-rate home equity loan? These loans often start at a lower interest rate, thus freeing up more cash flow to address your debt at a lower interest rate.
However, keep in mind the interest rate can increase at any time, thus increasing your monthly payment.
Option #3: Home Equity Line Of Credit (HELOC)
Taking out a line of credit with your home equity is the most flexible option. You will be approved for the entire amount of equity, but you will only be charged interest on what you use.
Additionally, whatever you money you pack back will again become available for you to borrow from.
Just like a home equity loan, interest rates on a home equity line of credit are usually low.
This will free up liquid assets for you each month to pay off any outstanding debt you may have. Better yet, you can take out a line of credit of any amount up to your total home equity value.
The flexibility of a home equity line of credit (HELOC) makes it an appealing choice for paying off debt. Some more benefits:
- They are 100% liquid, as good as cash in the bank.
- They are often eligible as forms of down payment.
- Relatively inexpensive compared to a home equity loan.
How Home Equity Loans Affect Your Credit Score
Another advantage of home equity loans is the positive impact it will have on your credit score. Your credit card accounts carrying balances will now have fully-available credit limits.
Because of this, your debt-to-income ratio is significantly lowered. Because this ratio represents a third of your credit, your credit score will rise quickly with this reduction in credit card debt.
The Importance Of Selecting The Right Mortgage Lender
Taking out a home equity loan to pay off your debt can be a great strategy. However, not all mortgage lenders have your best interests at heart. It is important to discuss the decision with your family and pick a lender who is right for you.
Refinancing your mortgage offers many benefits, including reducing your interest rate and monthly payment. It also can allow you to extract cash from the equity you’ve generated on your home.