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Debt Consolidation

Debt Consolidation

Is There Such Thing As Good Debt?

Debt critics tell you to get rid of all debt in order to build wealth and save for the future. However, there is one very notable exception that can be part of an effective financial management strategy for many people and that is leveraging the value in your home. Debt secured by your home has low interest rates and can provide liquidity in times of emergency or be used to consolidate more costly forms of debt.  Additionally, interest paid on home equity loans is usually tax deductible (check with your accountant to see if you are eligible).

Money you owe on your home is often called “good debt” and has some advantages over other kinds of debt. First, it’s secured, your ability to repay the debt is ensured by the value of the property- this security for the lender reduces their risk and that is the main reason interest on secured loans is cheaper than unsecured debt (like credit cards). Second, its effective interest rate is lower than market rate because, after deducting the tax savings benefit from the cost of borrowing, your effective cost of borrowing money secured by your home becomes much cheaper (market rate – tax savings = effective rate). Your home will likely appreciate in value in the long term (although it would be wise to be conservative in the very short term as we learned from the housing bubble in the mid to late 2000’s).

Some strategic ways to use home equity in your comprehensive financial plan:

  • to consolidate other debt for simplicity and to reduce overall expenses related to carrying debt.
  • to cover medical expenses, car repairs and other unexpected costs.
  • to take advantage of investment opportunities
  • to create access to immediate cash

Be careful how you use your home equity however.  It is not a good idea to buy a new car or finance unnecessary things with the equity in your home as it puts your home at risk should the value decline and the housing market suffer another correction. This could put you in a position of owing more on your home than it is worth.

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