This Is the Biggest Reason a Home Equity Loan May Not Be the Best Way to Consolidate Debt
Don't put your home on the line without thinking about the downside.
- Home equity loans offer affordable interest rates.
- They're commonly used to consolidate debt.
- When you use one, you put your home at risk.
When you consolidate debt, you pay off multiple existing debts with the new loan you've 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 that are secured by your home, they tend to have low interest rates, especially relative to other kinds of debts such as credit cards. But, before you decide to take this approach, you need to consider a major downside.
One big reason why you may not want to use a home equity loan for debt consolidation
The biggest reason you may want to think twice about using a home equity loan for debt consolidation is that doing so would require you to convert unsecured debt to secured debt.
What's the difference between secured vs. unsecured debt, and why does this matter?
When you have secured debt, that means there is collateral guaranteeing the loan. In the case of a home equity loan, your home is that collateral. Because the home secures the loan, the lender has a lien on the house that gives it a legal ownership interest.
In the event you fail to repay your home equity loan, the lender can easily move forward with foreclosing on the property. In other words, there's an extremely high chance that failure to repay the amount you owe could result in the loss of your house.
In most cases, the debt that you'd end up paying off using your home equity loan would not be secured debt. That's because 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 have collateral associated with them.
Since these debts are unsecured, there's almost zero chance you could end up losing your house because of them. While it is possible for lenders to pursue collection efforts and go to court against you to get a judgment that results in a lien being placed on your assets, they are less likely to do that. And, even if they did, this wouldn't generally lead to foreclosure of your home.
Converting unsecured debt to secured debt is also a big deal for another reason. Secured debt can't generally be settled or discharged in bankruptcy without losing the asset. But if you're really in over your head with your other debts, you can often work out a settlement with the creditors to accept less than full payment or could get the debt forgiven as part of a bankruptcy proceeding. While both of these things could hurt your credit, they wouldn't lead to the loss of your home in most cases.
Don't put your house at risk without careful thought
Before you decide to convert unsecured debt to secured debt, you need to think carefully about whether there is any chance you could become unable to pay back the home equity loan you're taking out.
If there's even a small possibility that you could run into trouble making the payments in full, you likely don't want to move forward with putting your house in potential jeopardy.
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