Debt Consolidation Home Loan Ideas And Warnings

Is a debt consolidation home loan a good vehicle for helping to eliminate your existing debt? What types of home loans are available? Is the interest tax deductible?

All good questions... let's have a look at them one by one starting with the different types available.

Types Of Home Loans For Consolidating Debt

First Mortgage

If you are lucky enough to own your home outright, then taking out a new first mortgage to pay off your debts is an option. First mortgages can be either fixed rate or adjustable rate and the entire funds are advanced at the time the loan is finalized.

Second Mortgage

Like a first mortgage, a second mortgage can be either fixed rate or adjustable rate and the funds are advanced in one lump sum. Depending on the equity you have in your home, interest rates on second mortgages tend to be quite a bit higher than firsts.

Cash Out Refinance

If you currently have a first mortgage on your home and you are interested in a debt consolidation home loan, a cash out refinance is an option. With a cash out refinance you simply get a new first mortgage for an amount greater than the existing first mortgage which is paid off with the new funds. The idea here is that the extra cash left over after paying off the existing mortgage can be used to pay off your other debts. In some instances a cash out refinance can actually lower the interest rate you are paying on your existing loan which is an added bonus. On the downside however, it might cost you something in the way of fees or penalties to pay out your existing first.

To summarize, first, second and cash out refinance mortgages all provide a fixed amount of money which must be paid back over a fixed period of time.

Home Equity Loan

The term "home equity loan" is often used to describe several different types of loans. But basically home equity loans are any loans secured by your home that were not used to purchase the home. The most common type is the HELOC (see below).

Home Equity Line Of Credit (HELOC)

A home equity line of credit, or HELOC for short, is similar to a regular line of credit except that it is secured by the equity in your home. When you qualify for a HELOC you can take out the amounts you need over time, and pay back what you want, whenever you want. The interest rates are adjustable.

Is The Interest On A Debt Consolidation Home Loan Tax Deductible?

I hesitate to give a yes or no answer here, and would advise you to check with your accountant. A "general" answer however is that you can deduct the interest on home equity loans up to $100,000 if they are not used to improve your home. If in the end you can deduct the interest, then of course this is an added bonus that should help with debt reduction efforts.

Is A Debt Consolidation Home Loan A Good Idea?

Based on "pure math", in many instances securing a debt consolidation home loan makes a lot of sense. You can usually reduce the interest charges on your debt significantly and as I mentioned above, in some cases, the interest will become tax deductible.

However, there are a few major WARNINGS.

By taking out a home loan to consolidate your credit card debt, you are now swapping unsecured debt (credit cards) for secured debt (the debt consolidation home loan). Now if you can't repay the debt, your creditors can come after your home!

A second caveat is this. Many people who take out a loan to pay off their credit cards, end up running the balances on those cards back up to their previous levels very quickly. They are then left with a home loan and credit card debts to pay back.

My advice? Before considering any debt reduction programs/loans, make sure that you get your financial house in order so that you treat the disease and not the symptom. Credit card debt is usually the symptom of an underlying disease called "spending more than you make". Once you have analyzed your incoming and outgoing cash flows, and prepared a budget that has you living below your means, then, and only then should you consider something like a debt consolidation home loan to help you get out of debt faster.