Home Equity Loans Improve Your Credit

Home Equity Loans Improve Your Credit

Home equity loans are another tool you can use to optimize your borrowing. If you have revolving debts that you would like to reduce, you can borrow against your home's equity to pay down those debts. The two main advantages of using this strategy are lower interest costs and potential tax savings.

Lower Interest Costs

A home equity loan usually has a lower interest rate than a standard credit card. This is because a home equity loan is secured by your home, and the bank can kick you out and sell your house if you fail to repay the loan. Credit cards, on the other hand, are not secured by anything. If you fail to pay them, the credit card company can sue you. However, you don't pledge any collateral when you open up a credit card account. Because the lender takes on more risk with a credit card account, the interest rate is higher. Therefore, if you shift your revolving debt to a home equity loan, the interest rate that you pay on that debt should decrease.

Potential Tax Savings

You might also get some tax savings by using a home equity loan to consolidate your debts. The interest you pay on a home equity loan is tax deductible in some situations. Essentially, this means that you don't lose all of the money you're paying in interest; some of the interest payment is effectively subsidized through your tax savings. Before you take this approach, check IRS Publication 936 to make sure that you can qualify to take the deduction.

Pitfalls of Home Equity Loans

Home equity loans can be dangerous, so you should not take the idea lightly. When you borrow against the value of your home, you're taking a serious risk. As mentioned above, your lender has the right to foreclose on your home if you fail to make payments on the loan. Is that risk worth it? You may only save modest amounts of money in exchange for that risk.
As with mortgage refinancing, home equity loans cost money. You need to take those costs into consideration before going forward. You might get a lower interest rate and enjoy some tax savings, but those savings could be wiped out by fees associated with closing the loan. When you factor in the risk of losing your home, it might not be worth considering. A home equity loan can help you optimize your borrowing in a few specific situations, but it does not work for everybody.