Sunday, September 13, 2009

Should You Use a Home Equity Loan to Pay Off Credit Cards?

With credit card interest rates rising right through the roof, some homeowners may be wondering whether a home equity loan or line of credit (HELOC) is the way to get their debts under control. The answer is a definite maybe.
While it's much harder to tap your home equity than it was in the past, it's not impossible. Yes, credit is much tighter in general these days, the decline in home values in recent years means that many homeowners no longer have any home equity to draw upon and banks are concerned about possible further declines in home values.
But many homeowners still retain considerable equity in their homes, particularly those who don't live in states like Florida, Arizona, Nevada and California, which have borne the brunt of the housing market decline. Such homeowners continue to be attractive clients for lenders. And many homeowners retain untapped credit in their HELOC, which is still available for them to draw upon.
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The question is, should they? They are some very attractive reasons for doing so. To begin with, a home equity loan or HELOC will very likely have a much lower interest rate than what many credit cards currently carry. In some cases, the rate on a home equity loan or HELOC may be one half or one third of the 17 percent to 24 percent currently charged on many credit cards - many of which were charging a mere 5 or 6 percent a few months ago. On a balance of $5,000, $10,000 or more, that's a hefty savings.
As mortgage interest, interest paid on home equity loans and HELOCs is also tax-deductable, up to a point. A couple can currently deduct the interest on up to $100,000 in home equity loans, and even more if the loan is put into home improvement.
So yes, it's possible to save a lot of money by borrowing against your home equity to pay off credit card debt. But many financial advisers say it's still a very bad idea.
A HELOC is secured debt
For one thing, you're trading unsecured debt for secured debt. Your credit card debt is unsecured - if you can't pay it off, there's nothing the lender can do to you, other than report you as a bad credit risk. However, any time of mortgage debt - including a home equity loan or a HELOC - is secured by your home.
If you can't make those payments, the lender is entitled to take your home. And particularly in the current economic climate, that extra $10,000-$20,000 you take out to pay off other debts could be the difference between mortgage debts that are manageable and those that are not should you or your spouse become unemployed or otherwise suffer a loss of income.
Another reason financial advisors recommend against using home equity to pay off credit cards is that it encourages continued dependence on deficit spending. Too often, the reasoning goes, someone who wipes out their credit card debt finds it too easy to start running them up again - after all, there's a zero balance and a few small charges won't matter. Pretty soon, they've run their balance back up again and now must contend with the twin perils of credit card debt AND a home equity loan tacked onto their regular mortgage.
Back into the credit card debt trap
This is how many homeowners got into trouble in the current housing crisis. Some people, it seems, are addicted to debt - they can't avoid the temptation of those seemingly insignificant purchases that quickly pile up into big balances on a credit card. For them, tapping a home equity loan doesn't so much provide them a way to get a handle on their debt as it does wipe the slate clean so they can start all over again! Only they're not yet done with their previous debts...
If you do take out a home equity loan to pay off your credit cards, take them out of your purse or wallet and put them away, so you're not tempted to use them for spur-of-the-moment purchases. Many experts advise that you actually cut them up at this point, so they can't be used, but you'll want to retain at least one for emergency expenses, such as a major care repair or as a reserve while traveling. But most of the time, keep it put away to avoid the temptation.
Tapping a home equity loan or line of credit can offer considerable savings for homeowners burdened with credit card debt. But only if they're disciplined enough to keep a lid on future expenditures and not fall back into the same credit trap.

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