According to the Federal Reserve, Americans carry on average, $5,800 in credit card debt from month to month. Making the minimum monthly payment on that debt would take 30 years to pay off and include an additional $15,000 in interest. According to the Administrative Office of the Courts, 2,078,415 bankruptcies were filed in 2005the largest number of bankruptcy petitions ever filed in any 12-month period in the history of the federal courts. With mounting credit card debt and the new tougher bankruptcy laws, people are looking for alternative ways of managing their debts.
Debt consolidation loans have become a popular way to free up money each month by consolidating several monthly credit card payments into a single lower interest loan. But, the question is whether it's best to consolidate your debts into a home equity loan or an unsecured debt consolidation loan.
Debt Consolidation Home Equity Loans
A home equity loan is a one-time lump sum of money you receive in the form of a second mortgage that is secured by the equity in your home. Equity is the difference between how much the home is worth and how much you own on your mortgage. Home equity loans generally have lower closing costs than refinance mortgages. Mortgage refinancing closing costs typically include: title and escrow fees, lender fees, points, appraisal fees, credit fees, insurance and taxes, with the major expense being the title and escrow fees.
A home equity loan is usually a fixed interest loan with rates that runs slightly higher than that of a first mortgage, unless it's a 125% Loan To Value (LTV) mortgage that allows homeowners to borrow beyond the value of their homes. Those rates usually run much higher that other mortgages and the origination fees can be as much as 10% of the loan balance. Home equity loans usually are repaid over less time than first mortgages, with repayment periods being as short as five years, but typically 15 to 20 years. Like a first mortgage, you have to pay off the balance of a home equity loan when you sell your home, so it's best to find out if your loan carries prepayment penalties or balloon payments, in case you sell your house before the loan matures.
Benefits and Drawbacks of Home Equity Loans
The main benefit of a debt consolidation home equity loan is that most states allow you to deduct up to 100% of the interest you pay on your taxes. Home equity loans typically have lower interest rates than unsecured loans, and borrowers can get relatively large amounts of money.
While debt consolidation home equity loans have attractive benefits, there are also major drawbacks. One is that if you dont make the payments, the loan can be foreclosed and you can lose your home even if you go into bankruptcy because secured loans are not dischargeable by Chapter 7 bankruptcy.
Another drawback is that exploitative lenders target homeowners, especially those with low incomes or poor credit. According to the Federal Trade Commission (FTC), there are many predatory scams, including:
· Equity Stripping: The loan is based on the equity in your home, not on your ability to repay it.
· Loan Flipping: The lender encourages you to repeatedly refinance the loan and often, to borrow more money, which incurs additional fees and points that increase your debt.
· Bait and Switch: The lender offers one set of loan terms when you apply, then pressures you into higher charges when you sign the loan papers.
· Deceptive Loan Servicing: The lender doesnt provide you with accurate or complete account statements and payoff figures. That makes it nearly impossible for you to determine how much you've paid and how much you owe.
If you are not sure whether a home equity loan is right for your needs, you may want to consider an unsecured personal debt consolidation loan.
Personal Unsecured Debt Consolidation Loan
If your credit is relatively good, and you are employed, you may be able to obtain an unsecured personal loan that you can use to pay off some or all of your high interest credit card debts. With a personal unsecured debt consolidation loan, no collateral is secured. This means that the lender is relying only on your promise to repay the loan according to its terms and conditions. While the loan amounts are not as much as those of home equity loans, they can be up to $10,000. Loans of up to $1,000 may not even require a credit check.
Unsecured debt consolidation loans have lower interest rates than credit cards, but they generally are higher than home equity loans. Some loans allow you to take anywhere from one to five years to repay, which can ease financial stress.
Benefits and Drawbacks of Unsecured Loans
The main benefit is that if you are forced into bankruptcy, the unsecured debt may be discharged in the bankruptcy proceedings because there is no collateral securing the loan.
The main drawback is that you must have good to excellent credit to get an unsecured loan, and the loan amount is usually less than a home equity loan. The interest rates on unsecured debt consolidation loans are typically higher, and it is not unusual for debt consolidators to obtain commissions of 10% or more on your loan, which may inspire them to encourage you to obtain a loan which is not in your best financial interests.
The answer to the question of whether you should get a debt consolidation home equity loan or unsecured personal loan all depends on your financial circumstances. If you have relatively good credit, are employed, and only have a few debts, you may want an unsecured personal loan. However, if your credit is not so good, or you have a lot of high-interest credit card debts or secured debts, a home equity loan may your best answer.
Resources: Federal Reserve, Federal Trade Commission(FTC),
The Administrative Office of the Courts, Bankrate.com - What home equity debt is Banking.About.com - The Basics of Home Equity Loans.
Maria Ny is an experienced free-lance writer who focuses on real estate & home financing related articles. You can read more debt consolidation related loan articles at http://www.mortgageloanoutlet.com and get more information about home equity loans and refinancing at http://www.mortgageloanoutlet.com/home_equity_loan.shtml
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