Home Equity Debt Management Solutions

If you have equity in your home and high-interest debt you'd like to consolidate, a home equity debt management solution may be for you. Home equity lines of credit and loans are available at historically low interest rates, and the payments may be tax deductible. However, not everyone qualifies.

Who Qualifies

As of March 2011, the days of using 100 percent or even 125 percent of your equity to consolidate debt are over. Since the housing decline, banks have restricted their lending to only the most qualified applicants. As a result, if you're considering applying for credit, review your finances and credit history carefully.

You must have a record of on-time payments, and you won't be able to access all of your home's value (lender rules will vary): the bank may require that you'll need to keep 20 percent equity. You'll need to have a full appraisal, as well as provide sufficient documentation that you can afford the new loan, including investment and bank statements, tax records and paystubs.

Home Equity Loans

A home equity loan is one lump-sum amount that is paid off over a pre-determined period of time and with a set payment. It usually carries a higher interest rate than a home equity line of credit, but may be more appropriate for paying lump-sum expenses or bills. It also may be appropriate for large purchases, such as a new car. You may choose either a fixed or variable interest rate (a variable rate will reset at a pre-determined point in time and your payments may change over the course of the loan). Closing costs may also be charged.

If you use a home equity loan to pay off debt, your lender will pay your creditors directly.

Home Equity Lines of Credit

Home equity lines of credit offer more flexibility. With a HELOC, the homeowner is issued a checkbook that draws against the home's equity, up to a predetermined limit. The homeowner is required to make a minimum payment each month, but also has the option to pay the line off in full at any time. Even if the HELOC is paid in full, the credit line stays open. HELOCs are usually appropriate for recurring expenses such as college tuition. You may choose between a fixed or a variable rate.

Advantages and Risks

Loans and HELOCs have two major advantages: first, the payments are often tax deductible, whereas credit card or other debt payments usually are not. Second, home equity interest rates are usually much lower than standard credit card interest rates. These two advantages permit a homeowner to reap significant financial savings if used with discipline.

However, homeowners should be very careful before taking on a home equity loan or line of credit. HELOCs are particularly risky, since the homeowner may use the funds for any purpose they choose.

Remember that the debt you're consolidating was previously unsecured. Now, it's become secured by your home; if you default, you risk losing your property. If the underlying behavior that caused the debt is not addressed, there is very little to prevent the homeowner from making the same mistake again, with much greater consequences.