Should You Use Your Equity to Pay for Debt Settlement?

If you’re unfamiliar with debt settlement, it’s where you contact a lender, and offer to make a cash payment to settle the debt but for less than you owe. Suppose, for example, you owed $8000 on a credit card. You could contact the bank and offer to make a lump sum payment of, say, $4000 to settle the debt. If the bank accepts your offer, it will treat the debt as if it had been paid in full – at least so far as you’re concerned. Unfortunately, it won’t report it to the credit bureaus this way. It will report your debt as “settled,” “settlement,” “settled for less than full amount due,” or some similar wording.

The downside

While debt settlement has become a popular way to achieve debt relief, It does have one big downside. You must have the cash available to pay for any settlements you’re able to negotiate. Getting back to our example of settling a $8000 debt for $4000, you’d need to have the $4000 ready to send the lender in the form of a wire transfer or certified cashiers check. Needless to say, if you’re struggling with debt it’s unlikely you’ll have enough cash available to pay for that settlement.

Do you have equity in your home?

If you have equity in your home, you could use it to pay for your debt settlements. There are three ways to cash out equity. The first is to refinance the mortgage. Today’s mortgage rates are at nearly all-time lows, though they are expected to gradually rise over the next year. For example, Consumer Direct is currently offering 30-year fixed-rate mortgage loans with an APR as low as 3.875%. The online mortgage provider, GSF, has 30-year fixed-rate loans with an APR of 3.77%. And American Financing is offering 30-year fixed-rate refi loans with an APR of 4.250%.

If you don’t want to refinance your mortgage, you could get either a home equity loan or homeowner equity line of credit. FlagStar Bank now has a home equity loan with an introductory rate of 4.49% with a loan to value of 80% required. It’s also possible to get a home equity line of credit (HELOC) with an APR of 3.99% from PNC Bank or 4.0% from Alliant Credit Union.

Note: To be eligible for the interest rates quoted here, requires a credit score of 740 or better.

Do the math

Now, compare these interest rates with the interest rates on your debts. If most of your debt is credit card debt, you’re probably paying anywhere from 14% to 21%. Plus$4000, you’d’s compound interest. If you’re making just the minimum payments on your credit card debts, you’re actually paying interest on interest. As an example of this, if you owed a total of $10,000 on your credit cards at 17%, and made just the minimum payment each month of $242, It would take you five years and three months to pay off the $10,000. And it would cost you $15,147 in interest.

In comparison, a home equity loan for $10,000 with an interest rate of 7.5% would require a monthly payment of just $100 for 48 months. And it would cost you only $2,750.23 in interest. So, if you were to take out a home equity loan and use the $10,000 to pay off your credit card debts, you’d realize potential savings of nearly $13,000.

If you don’t own your home

Of course, if you don’t own your home, you lack equity. In this case, you might be able to get a debt consolidation loan and use the money in debt settlement. If you have at least a “good” credit score (above 700 points), you could get an unsecured loan with a term of five years at an 11.21% interest rate, which would mean a monthly payment of just $218.

Hire a debt settlement company

If you can’t get a personal loan, another good option is to hire a debt settlement company. There are two advantages to this. First, it eliminates the need to have the cash available to pay for your settlements. Second, it lets you avoid having to haggle with your lenders yourself. Of course, debt settlement companies do charge for their services. The best ones charge a percentage of the amount of debt being settled, which usually ranges from 15% to 25%. However, the reputable ones, like National Debt Relief, don’t actually collect their fees until they have settled all of your debts. This means if you were to become unhappy with your program at any time, for any reason, you could simply drop out, and it wouldn’t have cost you a cent.

In conclusion

If you owe $10,000 or more and have a sufficient amount of equity in your home, you should think seriously about cashing it out and using the money in debt settlement. This will save you money versus trying to pay off the debt yourself. Plus, if you use a debt settlement company, you could be debt free in as few as 24 to 48 months.