Question of the week:With rates generally low right now, I'm thinking about taking out a home equity loan to pay off some credit card debt. Do you think that's a good idea? --Walter B.
Dear Walter,
You have plenty of company. According to the Consumer Bankers Association, debt consolidation is the most common use of home equity loans and lines of credit. Borrowing against your home equity to consolidate consumer debt is a fairly common scenario. When we asked the Armchair Millionaire community about their experiences doing this, we got two distinctly different kinds of responses. Here are two examples:
Go for it. "I took out a home equity loan at a low, fixed, rate and used it to pay off a higher fixed rate graduate school loan. Not only am I paying less interest, I can now I can deduct it all." --Erin
Stay away. "Good friends of mine got a home equity loan and consolidated all their credit card bills, which they couldn't afford in the first place. Within six weeks, they had charged the cards back up, putting them in even further over their heads." --David
As you can see from these two very different experiences, whether borrowing against your home to pay off other debt is a good idea depends entirely on you. If you stick with a disciplined program for paying off the debt and refrain from adding more credit card debt, it can be a great help, saving you hundreds or even thousands in interest and often giving you a tax deduction, to boot.
On the other hand, if you end up simply running up more credit card debt, it can be downright dangerous, putting your home at risk if you're unable to pay. I would suggest tapping home equity to pay down credit cards only when you're willing to make concrete changes in your spending habits and stop incurring additional debt.
If you do choose to make the plunge and take out that loan, use my checklist to do so wisely.
The Armchair Millionaire's Checklist for Tapping Your Home Equity
Know the differences. There are two different types of home equity instruments:
A home equity loan is for a fixed amount, usually has a fixed interest rate, and has a set term, typically 10 to 15 years. It is generally the best kind if you need a lump sum at one time (like to pay off all your credit cards) and don't anticipate needing to borrow beyond that.
A home equity line of credit allows you to write checks at any time during the life of the loan for any amount up to your credit limit. It will generally have a variable interest rate, and the amount of your monthly payments will vary according to the current interest rate and how much of the credit you have used. The loan must be repaid in full, or renewed, when it expires. A line of credit would be more appropriate when you need the money over time and want the flexibility to borrow exactly what you want, when you want.
Don't get in over your head. In many states, it's possible to borrow an amount greater than the value of your home. Steer clear of these loans-they will make it very hard to sell your home and generally create a hole that's difficult to climb out of.
Watch costs. Just like first mortgages, home equity loans and lines of credit carry some significant fees, including closing costs, points, application and processing fees, and a charge for an appraisal. These costs can vary significantly from lender to lender, so shop around. A "no closing costs" loan is not necessarily the best deal. Those savings could be more than offset if the loan has a higher interest rate.
THE BOTTOM LINE: There's an old adage that says you can never borrow your way out of debt. Whether that's true, however, is entirely up to you. If you're considering using home equity to pay off consumer debt, make sure you have a plan in place in advance for not getting in deeper.
Recent Comments