This is the main reason why a home equity loan may not be the best way to consolidate debt.
Don’t put your house on the line without thinking about the downsides.
- Home equity loans offer affordable interest rates.
- They are commonly used to consolidate debt.
- When you use one, you are putting your home at risk.
When you consolidate debt, you are paying off several existing debts with the new loan you have taken out. Home equity loans are one of many types of loans that can be used to consolidate debt.
There’s a reason home equity loans are popular for debt consolidation. Like first mortgages and other loans secured by your home, they tend to have low interest rates, especially compared to other types of debt such as credit cards. But, before you decide to take this approach, you need to consider one major downside.
One of the main reasons why you may not want to use a home equity loan for debt consolidation
The main reason you might want to think twice before using a home equity loan for debt consolidation is that it would require you to convert unsecured debt into secured debt.
What is the difference between secured and unsecured debt, and why is it important?
When you have secured debt, it means there is collateral securing the loan. In the case of a home equity loan, your home is that collateral. Because the house secures the loan, the lender has a lien on the house that gives them legal ownership.
In the event that you do not repay your home equity loan, the lender can easily seize the property. In other words, there is a good chance that failure to repay the amount you owe will result in the loss of your home.
In most cases, the debt you end up repaying with your home equity loan will not be secured debt. Indeed, many people use a home equity loan to consolidate credit card debt, personal loan debt, payday loan debt, and medical loan debt. None of these types of debt are associated with guarantees.
Since these debts are unsecured, there is almost no chance that you will lose your home to them. While it is possible for lenders to continue their collection efforts and go to court against you to obtain a judgment that results in a lien being placed on your assets, they are less likely to do so. And, even if they did, it usually wouldn’t lead to foreclosure on your home.
Converting unsecured debt to secured debt is also a big deal for another reason. Secured debt generally cannot be settled or discharged in bankruptcy without losing the asset. But if you’re really overwhelmed with your other debts, you can often reach a settlement with creditors to accept less than full payment or have the debt forgiven through bankruptcy proceedings. While both of these things can hurt your credit, they wouldn’t result in the loss of your home in most cases.
Do not put your home at risk without careful consideration
Before deciding to convert unsecured debt to secured debt, you should carefully consider the possibility that you may become unable to repay the home equity loan you are taking out.
If there’s even a small possibility that you’ll have difficulty making the payments in full, you probably don’t want to go ahead and put your home at potential risk.
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