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Home Equity Loan

Home equity loans (HELs) can be another resource for consolidating debt and differ from a HELOC. They normally have fixed interest rates and the borrower pays all closing costs.

Pros

One single payment on all your debt

Consolidating multiple debts to one loan with one monthly payment can have a positive financial and psychological effect, allowing you to focus on saving and managing your budget to stay within your means.

Fixed interest rate

In a lower interest rate environment, a fixed rate is usually recommended. Should market rates rise, your loan is not affected and your payments are more predictable.

Possibility of lower interest rates on your debt

Credit card interest rates can be 30% or more. For well qualified borrowers, a home equity line of credit could significantly lower the amount of interest you pay on your debt.

Potentially lower payments

Paying off your non-mortgage debts with a HEL can allow you to amortize your debt over longer periods, possibly lowering your overall monthly debt payments.

Improved credit score

Consolidating consumer debt with equity from your home zeroes out credit card balances, improving your credit utilization ratio (the amount you owe on credit cards vs. your available credit). Unused available credit represents responsible borrowing habits and can increase your credit score.

Cons

Higher closing costs and fees

Borrowers are generally responsible for paying all or most of the closing costs of a HEL.

Home at risk

Borrowing equity from your home to pay off consumer or any other non-secured debt turns your home into the collateral for all your debt. Should you default on your HEL payments, you could lose your home.

Reduced home equity

Borrowing from your equity reduces your ownership share, which could hinder your ability to sell your home if real estate values decline.

Potential for more debt

Paying off consumer debt with your home equity frees up credit on the paid off accounts. To reduce this risk, build a budget first and make sure you are resolved to not make any new purchases on credit until your HEL is completely paid off.

Less flexibility compared to a HELOC

HEL proceeds are deposited all at once and begin accruing interest charges immediately on the full amount of the loan. No additional borrowing is allowed without applying for a new loan.


Qualifying for a home equity loan

Loan-to-value ratio

A loan-to-value ratio on your home of under 80% is normally needed.

Credit scores

A FICO score of 740 or higher may qualify you for the best terms with most lenders. Borrowers with lowers credit scores may also qualify, but usually at higher interest rates, depending on the lender. Loan eligibility and terms vary by lender.

Debt-to-income ratio

A debt-to-income (DTI) ratio of less than 40% is generally required. Some lenders will approve loans up to 50% DTI.


Shopping for a home equity loan

Loan terms such as interest rates, length of loan repayment, fees, and processing speed can vary widely by lender. It can pay to shop around.

A good place to start can be your local credit union or bank. Getting several quotes and using comparison tools such as Forbes or Bankrate.com is a good way to begin your search for the best lender to meet your needs.