Debt seems to be the watchword of the 21st century. The European debt crisis, the U.S. fiscal crisis and debt accumulation throughout the world have left the global economy in shambles. U.S. consumer indebtedness has restrained growth considerably as consumers pay down their debts instead of spending or investing. Homeowners in debt are turning to debt consolidation to clean up their balance sheets. The foreclosure crisis has been devastating to homeowners who are already up to their eyeballs in debt. Consolidating their debts seems the only way out.
Home Equity Loans
This option works if the homeowner has equity built up in his home. Home equity loans take the positive difference between the mortgage balance and the value of the home as collateral. The lender hopes to sell the home for its current price and claim the equity if the homeowner defaults. Depending on how badly the homeowner is in debt, taking out a home equity loan may not be feasible. The interest rate needs to be lower than the rate on all of his other debts. If the rate on the home equity loan is higher, it defeats the entire purpose of taking out the loan in the first place.
Home Equity Line of Credit (HELOC)
A HELOC is much more convenient than a home equity loan. The homeowner can draw on the HELOC as he pleases, and he is under no obligation to take the full amount of the equity all at once. The equity in the home acts as a credit limit that rises or falls as the amount of equity does. The interest rate on a HELOC tends to be higher than with a home equity loan, which makes a HELOC slightly more risky. HELOCs are used to make home improvements, invest in a business or help a child pay for college. They can also be used to consolidate debt. It might be better to pursue a home equity loan since the HELOC terms last for a long time.
Cash Out Refinancing
In terms of debt consolidation, this is the last option the homeowner should consider. Cash out refinancing replaces the first mortgage with a second, and the homeowner gets to pocket the difference between the two. While cash out refinancing may come with a lower interest rate, it increases the total debt load and resets the amortization schedule. Indebted homeowners are better off avoiding this route.