you are like most Americans, your mail box is filled with offers for
credit cards, mortgage refinancing and home equity loans. Many of those
offers stress the benefits of moving existing balances to the new lender.
While that may sound appealing, especially if the new loan offers an
attractive initial interest rate, it is important to consider all the
factors associated with debt consolidation.
Consolidation is Debt Management, Not Debt Elimination
Moving all your outstanding loan balances to one lender will not reduce
the amount you owe. You must ultimately pay off the loan and pay interest
until the loan is repaid. Your goal should be using debt wisely. Here
are some reasons to consider debt consolidation:
- Lower rates
- Different types of loans have different rates. Credit card debt
usually carries higher rates than loans that are secured by an asset
such as a home or car.
- Lower payments
- You payment is determined by the amount you are borrowing, the
rate being charged and the length of time over which you are paying
off the loan.
- Tax benefits
- The interest you pay on a home mortgage or home equity loan may
be tax deductible while interest on credit card debt and most personal
loans is not. Consult your tax advisor for more details.
- Peace of mind
- Dealing with one lender, making fewer monthly payments and having
a plan for paying off your total debt can reduce your financial
- Improve credit
record - Having fewer debts and making timely payments can make
it easier (and potentially cheaper) to secure loans in the future.
starting point is to determine what you have borrowed and the interest
you are currently paying. Here is a worksheet that can help.
- Examine the
types of debt you have and the rates you are paying.
- Are these the
types of debt you want? - There may be less expensive alternatives
within the category such as replacing your credit card with one
that offers lower rate. You may also wish to consider converting
one type of debt into a different type that offers lower rates,
such as using a lower interest rate home equity loan to pay off
other more expensive types.
- If you decide
to replace debt with debt secured by real estate (mortgage or home
equity loan), consider the alternatives and remember the risks.
You will be pledging your home as collateral.
the Attractions of Home Equity Loans
- It easy to apply and the approval processes can be fast. The process
is often simpler than if you were applying for a new mortgage. Once
you are approved, the commitment acts like a line of credit. You do
not have to borrow it all at once.
Interest rates - The interest rates charged on home equity loans
are usually greater than those on first mortgages but less than those
on credit cards. Often, you are only required to pay the monthly interest
with the principal to be paid later.
- For many individuals that itemize their tax deductions, the interest
paid on home equity loans can help save some income taxes. There are
some limits on this type of interest deduction so consult with your
tax advisor for more details.
Flexible uses - Even though you are borrowing against your house,
there is no requirement that the money be used on your house. A home
equity loan can be the source of funds for paying off credit card balances,
college tuition or even to buy a car.
owe it to yourself to determine if consolidating your debts into one
loan makes sense. You may be able to reduce your interest rate and if
you use a home equity loan, you may be able to save some taxes. However,
just like with any financial transaction, you must consider all the
factors and risks.