You’re facing a lot of debt, and you’ve been researching different ways to eliminate that debt. During your research, you’ve probably read a lot about using your home equity to help consolidate your debts. Many people will tell you about the benefits of tapping into your home equity to consolidate your other high-interest debts. Unfortunately, those people don’t talk about the risks and downfalls of using your home equity to consolidate your debt.
While there are great benefits to using home equity to consolidate your debt, there can be some major long-term repercussions.
These are the risks and downfalls to think about before you choose to consolidate your debt with your home equity.
1. It will take you longer to pay off your debt
One of the main reasons why people use a HELOC (Home Equity Line of Credit) to consolidate their debt is because it usually has a very low-interest rate. Especially in comparison to high-interest debt, like credit card bills, using a HELOC means paying less in interest. But are you really paying less in the long run?
When you choose a HELOC, you may be opting for a lower interest rate, however, your repayment terms will increase. When you extend your terms from a few years to as many as 30 years, the overall cost of your debt can actually increase, even if you have a lower interest rate. You may be paying less monthly, but long term, you’re paying more for your debts over a longer period of time.
Another important factor to remember is that HELOC interest rates are variable. So, you could be refinancing for a lower rate now, but that rate can increase. If the rate increases, you may again, be paying more in the long run.
Before opting to use a HELOC to consolidate your debt, it is extremely important to do the math. Find out how much you will be paying in the long run and whether it is worth it or not.
2. You may rack up even more debt
Let’s say you decide to tap into your home equity to pay off your credit card debt. Your monthly payments are now lower, and you’ve freed up space on all your credit cards.
Here is where the trouble sets in for many consumers.
When people see that they have repaid their credit card debt, they can end up using credit cards for again for unexpected or emergency expenses and are often tempted to spend again. They begin rebuilding that debt where they will now have even more trouble repaying it. Remember, when you consolidate your debt using home equity, your debt is not gone. Your debt, which is now secured against your home, still needs to be repaid, so be mindful of your spending and taking on more debt.
3. You might run out of equity
As a homeowner, you are able to access your home equity whenever you need it (depending on the terms of your mortgage agreement, of course). People begin seeing their home as a resource where they can use their equity whenever they need or want it. We’ve seen it before where people start treating their equity-like their own personal ATM. But equity is not an unlimited resource. It’s not something you should access for a fancy vacation or a new car. If you use up your equity, you may not have any left when you need it the most. It’s better to leave your home equity alone and only access it if you truly need it.
4. You could be violating the terms of your loan agreement
Personal loans are usually meant for consumer debt. Certain types of debt cannot be paid off using another type of loan or home equity. As an example, if you’re using a HELOC to pay off your student loan debt, you could be violating the terms of your loan agreement.
Your lender may not notice what you’ve done, but it can be a major problem for you if you’re caught violating the terms of your loan agreement. You could face significant fines, or you may need to repay the money you used, right away. This could mean coming up with thousands of dollars in a short time frame to repay your lender and avoid any more fines.
5. You risk losing your home
Consolidating your debt is a good thing, but only when it’s done right for the right reasons. When things go wrong, you can find yourself in a very serious and dangerous financial situation. Paying off high-interest debt with low-interest debt seems like a smart move, but that’s only the tip of the iceberg.
Diving deeper, you’re transferring unsecured debt into debt that uses your home as collateral. If you are unable to make payments, you risk losing your home. Yes, while there are risks when you don’t make your credit card payments on time, the consequences aren’t as severe as losing your home.
The bottom line
You should only borrow money for purchases that will improve your financial situation in the long run. Don’t put yourself in a situation where you are putting more at financial risk because of your debt. For the best advice on how to consolidate your debt call 4 Pillars today. We can help you create a debt-relief plan you can actually complete to give you the highest likelihood of financial freedom. To book your free consultation, give us a call at one of our three locations across Northern Ontario. You can reach our Muskoka & Parry Sound office at 705-640-0187, our North Bay office at 705-980-0158, or our Sudbury office at 705-806-1252. A brighter and better financial future is just a phone call away! Why wait any longer?