Refinance or home equity loan for debt consolidation?

By Michele Lerner
Mortgage Credit Problems Columnist

Debt consolidation loans, often home equity loans or home equity lines of credit, can help consumers get debt relief by combining all their monthly payments into one loan, usually at a lower interest rate than charged by credit card companies. The advantage of debt consolidation loans is that typically the closing costs and fees are lower than on a home refinance.

Home equity loans for debt consolidation

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Consumers with credit problems need to be wary of tying their debt to their home. Moving your high-interest debt into a mortgage with lower interest sounds great, but remember that your mortgage is secured by your home. If you fail to make the payments for this new loan, you could lose the property to foreclosure.

Another potential danger is that once credit card debt is consolidated into the new loan, some consumers will be tempted to take advantage of their newly available credit and overspend again.

Qualifying for a home equity loan will depend on the available equity in the property as well as the credit score and debt-to-income ratios of the borrowers.

Bad credit refinancing for debt relief

A second option for homeowners with debt problems is a home refinance. Like a debt consolidation loan, a mortgage refinance typically requires equity in the home (though some government programs such as the Home Affordable Refinance Program are available to help eligible underwater homeowners). The type of loan that can be approved will depend on the credit of the borrowers and their income.

A home refinance can work in one of two ways to provide debt relief:

  1. A cash-out refinance. If sufficient equity is available, you can take out a lump sum of cash at closing to pay off their other debts, thereby increasing the size of their mortgage. Even with the higher rates that borrowers with bad credit usually pay for mortgages, the interest may very well be less than the amount charged by credit card companies, which don't use an asset such as your home as collateral.
  2. Lower monthly housing payments. If you don't have enough equity in your home to pay other debts, a refinance may still make sense because you may be able to lower your mortgage payments by taking advantage of today's low mortgage rates. You can use the monthly savings to pay off your credit card debt more quickly.

Just like with a debt consolidation home equity loan, the main concern should be your ability to repay the loan so that you don't face foreclosure. In addition, closing costs and fees can make refinancing a little more expensive than a home equity loan.

To find out the kind of debt relief that is available to you through a home equity loan or refinance, complete the form on this website to start getting mortgage quotes.

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