RX for Debts: Facts on Debt Consolidation

Debt Consolidation Options

If you’re burdened by debts, and caught in a cash crunch, tapping the equity in your home may provide a way to regain some sanity in your finances. Credit cards often charge interest as high as 20-25% per annum. If you use your home equity to pay off credit card debt, you may be able to enjoy a lower rate of interest with payments spread over a longer-term.

Debt consolidation allows you to combine high-interest debts like credit cards and auto loans into a single monthly payment which is lower than what you would be paying for the sum of your individual debts.

If you are caught in a vicious circle of overwhelming monthly debt payments which exceed your capacity to pay, leading to late penalties which further hike up the interest rates — then you need help. Through debt consolidation, you cash out some of the equity in your home to pay off pending debts. Then you make only one payment monthly for the home equity loan, home equity line of credit or new mortgage. Please read our section on Cashing Out Equity for a detailed explanation of the types of plans available to extract equity from your home.

Here are some of the important features which may make debt consolidation a lifesaver for you:

Now let’s consider an example of how debt consolidation might work.

Appraised Value of Home$200,000Debt #1$35,000
Loan-to-Value Ratio – 80%x .8 = $160,000Debt #2$15,000
Existing Mortgage$100,000Debt #3$5,000
Available Equity$60,000Total debt$55,000

In this example, you could borrow up to $60,000 using any of the three methods we have described — cash-out refinancing, home equity loan or home equity line of credit. After paying off your total debt of $55,000, you would come out with $5,000 in discretionary money, if you borrowed the entire amount available to you. Your monthly payments would be lower than the total payment you are making monthly for a mortgage and three debts, and the interest rate would probably be much lower.

What’s the Conclusion?

Debt consolidation offers the following advantages: