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When you consolidate debt, you are paying off several existing debts with the new loan you took out. Home equity loans are one of the many types of loans that can be used to consolidate debt.
There’s a reason home equity loans are popular for debt consolidation. Like first mortgages and other loans secured by your home, they tend to have low interest rates, especially compared to other types of debt like credit cards. But, before you decide to take this approach, there is a major downside to consider.
One of the main reasons you may not want to use a home equity loan for debt consolidation
The main reason you might want to think twice before using a home equity loan for debt consolidation is that it would require you to convert unsecured debt to secured debt.
What is the difference between secured debt and unsecured debt, and why is it important?
When you have secured debt, it means that there is a security for the loan. In the case of a home equity loan, your home is that collateral. Because the house secures the loan, the lender has a lien on the house which gives them legal ownership rights.
If you do not pay off your home equity loan, the lender can easily proceed with the foreclosure of the property. In other words, there is a good chance that failure to repay the amount you owe will result in the loss of your home.
In most cases, the debt that you end up paying off using your home equity loan would not be secured debt. This is because many people use a home equity loan to consolidate credit card debt, personal loan debt, payday loan debt, and medical loan debt. None of these types of debt are associated with collateral.
Since these debts are unsecured, there is almost no chance that you will end up losing your home because of them. While it is possible for lenders to continue their collection efforts and go to court against you for a judgment that results in a lien on your assets, they are less likely to do so. And, even if they did, it usually wouldn’t result in your home being foreclosed.
Converting unsecured debt to secured debt is also a big deal for another reason. Secured debts generally cannot be settled or discharged in bankruptcy without losing the asset. But if you are seriously overwhelmed with your other debts, you can often come to a settlement with creditors to accept a less than full payment or get the debt forgiven in bankruptcy proceedings. While both of these things can hurt your credit, in most cases they would not result in the loss of your home.
Don’t put your home in danger without careful consideration
Before deciding to convert unsecured debt to secured debt, you should think carefully about the possibility that you may no longer be able to repay the home equity loan you take out.
If there is even a small possibility that you will have trouble making the payments in full, you probably don’t want to go ahead with the potential endangerment of your home.
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