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Last Updated on January 20, 2024 by Work In My Pajamas
Buying a home isn’t the attainable goal or safe investment it used to be, but that doesn’t mean it’s a bad idea. Rent is skyrocketing in large metropolises across the U.S., and if we’re spending money for a place to live, why not have most of it go toward our bottom line?
There’s also the fact that having equity in a home can provide an extra level of financial protection. Take credit card debt, for example. The average household that carries a revolving balance has almost $7,000 in credit card debt. This may not seem like a huge amount compared to the average household mortgage ($184,417), auto loan ($28,033) or student loan ($47,671). However, the interest rates of the latter three debt types can’t compare to the average 15 percent interest rates that credit cards carry. Consumers with bad credit could be paying as much as 25 percent!
If you made a good decision to purchase a home a while back but are seeing a solid chunk of your income go to credit card interest each month, your home may be able to help you out.
Here are three home equity options to deal with debt:
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Cash-Out Refinance
Cash-out refinances allow debtors to leverage their equity for lump-sum cash. This is done by replacing the original mortgage with a new mortgage and terms. Because of the convenience of managing only one mortgage and getting access to a large amount of cash quickly, cash-out refinances are by far the most popular of the three home equity options. At the same time, cash-out refinance, despite the lower interest rates they offer over HELOCs and home equity loans, usually have more expensive closing costs. The interest you pay through a cash-out refi may be tax deductible, however. Cash-out refinances require a good credit score and debt-to-income ratio to obtain.
Home Equity Loan
Like cash-out refinances, home equity loans generate a lump sum of cash based on how much a borrower wants to tap into their home’s equity. The interest paid on a home equity loan is also tax deductible. However, unlike a cash-out refi, home equity loans don’t replace a mortgage; they add a second one to the mix, and homeowners must start repaying it immediately. There’s also the issue of the loan now being tied to your house. If you can’t keep pace with both of your mortgage payments, you lose your home. Home equity loans usually have higher closing costs than home equity lines of credit, but can leverage as much as 90–95 percent of a homeowner’s equity, allowing consumers to free up major funds for large expenditures.
A decent credit score and debt-to-income ratio are needed to secure a home equity loan with favorable terms, but options may be available for those with worse credit as long as they can prove their repayment ability.
Home Equity Line of Credit (HELOC)
The least common form of tapping into home equity is to take out a home equity line of credit, or HELOC. HELOCs work similarly to a credit card by only charging interest when money is borrowed. This makes it an advantageous strategy for debtors who need cash-flow support but don’t need access to a large amount at one time.
HELOCs do carry varying interest rates based on the amount borrowed, though — so it’s a suboptimal strategy for consumers wanting fixed payment amounts. Home equity lines of credit can also include a maintenance fee, annual charge and per-transaction fees — not to mention an appraisal charge to start the HELOC process. And it might go without saying by now, but HELOCs are risky in that your home becomes collateral for your debt. Like a cash-out refi and home equity loan, HELOCs require good credit and debt-to-income ratios.
Options for Homeowners with Bad Credit
Undergoing one of these three strategies could be enough to lift you out of crippling credit card debt. But be advised that these aren’t your only options — at least if you don’t want or need to keep your home. If you have enough equity in your home to make some money on a sale and aren’t tied to your home, why not downsize? Allocate any money you make on the sale and buy a smaller house with a much smaller mortgage — or rent if the price is right.
If a household’s credit scores put home equity options out of reach and you want to stay in your home, declaring chapter 13, or opting for debt settlement through providers like Freedom Debt Relief are worth evaluating. Chapter 13 bankruptcy discharges a debtor’s balances as long as they make court-ordered payments for three-to-five years. Debt settlement involves stopping credit card payments while a third-party service negotiates with creditors to lower a debt balance or balances.
Debt settlement can take anywhere from two-to-four years. Both of these options cost money even though they do help alleviate debt. Bankruptcy brings attorney fees, court costs and financial management courses whereas debt settlement companies charge a fee on any debt they negotiate that a debtor agrees to pay. Both options impact credit negatively, staying on reports for up to seven years. But seeing as these are last-resort options for households with already destroyed credit, the side effect isn’t as harmful as it seems.
Now that you’re armed with all you need to know, evaluate how much equity you have and how much you need to pay back as you weigh the pros and cons of each debt relief method above.
