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Be careful with 125 loans

Many borrowers think they have found the perfect loan — 125. But you have to be careful when considering this product. A 125 loan is named for the amount of equity you can withdraw from your home, which is usually 125%. Some loans are guaranteed by your home and some are not, making them a mixed type of loan. The unsecured portion causes your interest rate to be higher compared to a fully secured home equity loan.

Many borrowers switch to 125 loans because they can only make one payment to their lender instead of multiple payments to multiple lenders. The single payment is often lower than the total of all reimbursed payments, due to the difference in interest rates. The rates are often much better than credit card rates, but if you include other loans, such as student loans, you may actually increase some of your debt rates.

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For example, you might have a car loan with a balance of $11,000. You have an interest rate of 8.5% and a remaining payment of 4 years. You put the money into your 125 loan, which has an interest rate of 11.5%. You have actually raised your interest rate.

If you insert a credit card with a balance of $12,000 and an interest rate of 19%, you lower your rate. But you will see payouts over ten years. The real danger comes when borrowers take 125, pay off their credit card debt and then go out and max out the cards again. This is called reloading. You now have double the debt to pay off. You are in a worse situation now and are risking losing your house.

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When you take out 125, you have to be dedicated enough to cut every credit card on the spot. This will help you avoid temptation. You might say, but wait — I have to deduct 125 interest on my income tax. Yes, you save 28 cents for every dollar you spend. Does not make sense. Plus, the amount of interest on the loan above the value of your home is not tax-deductible. If you deduct it, it will bite you in taxes.

You are also now upside down in your home equity. You owe more than the value of your home. You can’t sell it until the value of the house increases or you pay off the loan enough to reduce the balance below the value of the house. That takes about five to 10 years in most cases.

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If you are forced to sell your home, you may have to pay money at closing just to get it out of your hands. You pay to sell your home. If you plan to stay at home for a long time, you may not have to worry too much about this.

But keep in mind that the unexpected happens. When you open yourself to a lot of debt, you are risking your future. Taking out a 125 loan to get rid of debt is not necessarily your best option. This is certainly not an easy way out, as you may have said. This is the same debt, just a new place. Be careful, this time your house is at stake.