Consolidating debt using home equity vs a traditional loan
Refinancing or extending an existing loan with funds from either the same or a different bank or financial institution is called debt consolidation.
There are several types of loans you can use to consolidate your debts, including home equity loans and a traditional loan.
A home equity loan allows you to borrow money using your house as collateral to invest in shares or property, repay your debts, renovate or pay for lifestyle expenses. An equity loan allows you to borrow a lump sum and pay it back every month. Its time is typically 5-15 years.
While a traditional bank is financing provided by a bank and is paid back over a fixed period. Traditional financing is usually issued based on four C’s which are collateral, capital, character, and capacity. Between April and May 2019, Australian had fixed loans for debt consolidation, increased by $11.9 million, after already rising by $30.3 million between January and February 2019.
Why should you consolidate your debts?
Debt consolidation is always a good idea because it combines high-interest debts, such as credit card bills, into a single, lower-interest payment. It reduces your total debt and reorganizes it, so you pay it off faster. When you consolidate debts, you receive a 0% interest, balance-transfer credit card to transfer all your debts onto this card and pay the balance in full over a certain period. You receive a fixed-rate debt consolidation loan which allows you to off your debt, then pay back the loan in instalments in 3-5 years.
Guide to consolidating your debts
This guide will help you determine if ever debt consolidation is good for you.
- The first step to debt consolidation is to list the debts you want to consolidate.
- List the total amount owed, the monthly payment due and the interest rate paid next to each debt.
- Add the total amount owed on all debts to determine how much you need to borrow with a debt consolidation loan.
- Add the monthly payments you currently make for each debt to determine the comparison amount for your debt consolidation loan.
- Approach a bank, credit union or online lending source and ask for a debt consolidation loan or take any personal loan or even a home equity loan that covers the total amount owed.
- Compare what you currently pay each month and what you would pay with a debt consolidation loan or the home equity finance.
Home equity debt consolidation
Home equity loans have amazing benefits. They usually have a lower interest rate than credit cards and other types of personal loans. Home equity finance is flexible, you can use it for any purpose and access it whenever you want. You can pay off home equity loans faster by making additional payments each month with no added fees. However, home equity might slightly decrease your credit score, but generally not enough to impact your ability to secure future loans. With home equity, you can borrow an amount depending on your property’s current market value and how much you have remaining on your home loan. Roughly, if your home is worth $700,000 and the remaining amount on your home loan is $300,000, you have home equity worth $400,000.
Debt consolidation using a traditional loan
The traditional method of debt consolidation means taking out one large loan from the bank or credit union and use it to consolidate all your debts. Debt consolidation loans are effective, but you can be rejected for it if you have a less-than-perfect payment history and low credit score. If you get approved while you have a low credit score, the loan you get will carry a high-interest rate. Here are the benefits of debt consolidation:
Single monthly payment
Consolidation simplifies the process of paying several loans that have different repayment dates and interests.
Lower interest rate
This allows you to make more substantial dents in your debt.
Pay off debts faster
Paying different loans with different interest rates might take you up to 20 years to finish but after you have consolidated your debts, you only take 3-5 years to pay off.
Examples of debts that can be consolidated
Although debt consolidation is a good decision when you want to improve your financial status and your credit score, not every debt can be consolidated. You can only consolidate small debts such as:
- Credit Card Debt
- Unsecured Loans
- Medical Debt
- Past Due Utilities
- Collection Accounts
- Payday Loans
Disadvantages of using home equity as debt consolidation
When you use home equity you should keep it in mind that it is also a loan that needs to be repaid. You should learn to budget and address the factors that got you into debt. Because home equity debt consolidation means taking out a loan with your home equity as collateral, failure to abide by the terms can result in you losing your home. It is more important to get loan terms that you can handle, otherwise, you’ll be back in square one.
Disadvantages of traditional debt consolidation loans
Choosing traditional loans to consolidate debt will result in higher fees. Companies that specialise with consolidation may charge very high upfront fees and interest rates that are close to the maximum allowable rate for mortgage loans. Which makes you use most of your monthly instalment to pay interest and make it difficult to pay off your debt. Sometimes interests rise unexpectedly and put you under pressure.
- Low-interest rates do not mean you are saving. Other consolidation loans stretched over a long period, which means that your total interest payments add up to a very expensive debt.
- Consolidating all short-term loans over much longer periods, even at a slightly lower rate, means paying a lot more interest in the long run.
- Debt consolidation can lead to more debts. When you see the “zero” balance on their credit card as a green light to go spend more. This will only make things worse.
- Debt consolidation does not reduce your debt. It replaces current debt with different debt and is therefore not a solution for over-indebted consumers.
How can you apply for a consolidation loan in Australia
- When you need to consolidate your debts in Australia, you should be permanently employed.
- Have Australian citizenship, or Australian permanent residency, or an eligible visa
- Live in Australia
- Meet minimum income requirements
- Have a good credit rating
Debt consolidation can also be a bad idea
Not every debt needs to be consolidated. It does not address endless spending habits that create debt in the first place. It is also a solution when you have too many debts and have no hope of paying it off even with reduced payments. If you have a small debt you can use your own pace to pay it off within six months to a year and you’d save only a negligible amount by consolidating, don’t bother.
Consolidating debt using home equity vs a traditional loan
You can consolidate debts using either home equity or a traditional loan. They both have low-interest rates and you can pay it off in a short period. However, you can use home equity if you have an existing property and have paid off more than 20% of your mortgage. A traditional loan usually does not need collateral for debt consolidation.