Using a home equity loan to pay off credit cards
Definitions
Just what is home equity anyhow? Home equity is the difference between what your property is worth and what you owe on it. If your home is currently worth $200,000, for example, and your mortgage balance is $150,000, then you have $50,000 of equity.
Under normal circumstances, this equity remains untapped, increasing slowly with time. There are, however, a couple of ways to use home equity for other purposes:
- A home equity loan (HEL) is essentially a second mortgage. The homeowner borrows a lump sum from the bank using the equity in their property as collateral. This sort of loan generally has a fixed interest rate and a term of ten to fifteen years.
- A home equity line of credit (HELOC) is slightly different. HELOCs are revolving credit accounts, much like department store credit cards. The homeowner can borrow money repeatedly, as long as the HELOC’s credit limit is not exceeded. HELOCs generally have variable interest rates.
Traditionally, home equity loans (and lines of credit) have been used to fund property improvements such as remodels and additions. Over the past decade, however, it has become fashionable to use this money for consumer spending. Or for debt consolidation.
Robbing Peter to Pay Paul
Using home equity to pay off debt is an appealing option. You can obtain a loan with an interest rate in the neighborhood of 8%. Your credit cards probably charge twice that. If you’re paying on multiple credit cards, it’s likely that your combined payments are higher than the single payment on a home equity loan would be. And in most cases, interest paid on a home equity loan is tax deductible, the same as mortgage interest.
However, home equity loans are not a panacea. They don’t eliminate debt — they just shift it from high-interest to low-interest accounts. And if you fail to change the habits that led you into debt in the first place, you will likely accumulate even more debt in the long run. Most importantly, a home equity loan puts your house at risk — credit cards do not.
Despite these drawbacks, debt consolidation can be an excellent way to arrest the downward spiral and to take control of your finances.
My Story
I took out a home equity loan to pay off my credit cards.
In 1998, I had more than $16,000 in credit card debt. I applied for — and was granted — a home equity loan. I used this money to pay off my outstanding debt. I cut up my credit cards. When I was certain that my balances were paid in full, I cancelled the accounts.
I paid faithfully on this loan for five years (it had a ten year term). But when we bought our new home in 2004, the intricacies of the transaction (read: my lack of savings) forced me to fold my previous home loan into a new HELOC: $21,000 at 6%.
For a while, I made the interest-only minimum payments. Time passed. The minimum payments began to rise. I was puzzled until I noticed that my interest rate was also increasing. This was alarming, and it prompted me to attack this debt in earnest. In fact, just this month I mailed the final check to pay off my home equity line of credit.
Tapping home equity allowed me to get rid of high-interest credit cards and begin down the path of smart personal finance. It wasn’t an immediate turn-around — I took out a car loan and a couple of personal loans before realizing the error of my ways — but the change did happen, and this second mortgage was an important piece of the puzzle.
My Advice
After carrying a home equity loan for nearly a decade, I learned some things along the way:
- The interest rate on your home equity loan should be lower than the interest on your credit cards. This is likely the case. However, if you have cards with low rates, you’re better off exercising the discipline to pay them down instead of taking out the loan.
- I prefer a home equity loan to a home equity line of credit. The latter is more flexible — you can draw on it repeatedly if you need — but the interest rate is higher. Your goal is to reduce your debt burden, not increase it.
- Arrange to have the bank pay off the balances on your cards when the loan is funded. If they’re not able to do this, make paying off your credit cards the first thing you do when you receive the money.
- Destroy your cards. Burn them. Cut them up. Shred them. I believe it’s important to avoid credit cards completely until your home equity loan has been repaid.
- As you receive statements from your credit card companies indicating $0 balances, call to cancel the cards. Many experts warn against closing credit card accounts because it dings your credit score. My credit score dropped some because of it, but I don’t care. I’d rather have a good credit score and not be tempted to new debt than have a great credit score and be piling up the problems.
- Live without credit. Yes, you may need to buy a car on credit, but otherwise refuse to take on new debt. Taking on new debt simply defeats the purpose, and puts you in worse shape than before.
If you follow these guidelines, the equity in your home can be a valuable tool to help you escape from consumer debt.
Conclusion
There are some real dangers associated with using home equity (which is debt secured by your property) to pay down credit card debt (which is unsecured debt). If something goes wrong, you could lose your home.
If you do choose to go this route, please make a commitment to avoid credit cards (and other consumer debt) completely until you’ve finished repaying the loan. If you’re able to exercise a little self-discipline, a home equity loan can be an excellent way to put the brakes on bad habits, and a chance to make a fresh start.
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There are 42 comments to "Using a home equity loan to pay off credit cards".
It would be interesting to see the % of people who use HELO to pay off credit card debt who end up having HELO debt and run the credit cards back up. I would advise working to change your money habits, living on a budget, living without credit cards and working a debt snowball for at least 6 mos. before going with a HELO. If you don’t change your lifestyle and your money habits you are just going to have more debt.
I agree if you are smart and stick to a game plan a HELO can be the way to go, pay off all your debt and then pay off the HELO but also get a tax deduction on the HELO. I personally wouldn’t risk my home to pay off unsecured debt.
My story is likely the typical ‘dumb money’ person’s story. About two years ago we paid off about $30,000 in credit cards and a relatively small truck loan with a home equity loan.
Yay, we are so brilliant, the debt just disappeared! We thought…of course we were dumb and had not changed our habits, which is why today I have the large mortgage balance and (when I started my little financial turnaround) a new $25,000 in credit card debt.
Shifting your credit cards to a home equity loan is fine mathematically, but if you don’t change your behavior it’s a horrible idea.
Most credit card companies will reduce the rate to something close to your home equity if you just ask politely. The line we coach people to use is, “I am trying to get out of debt and I need your help. Will you please reduce my interest to 0% for 12 months so I can get out of the hole I have dug for myself?” Usually they will come back with some offer at like 3 6 or 8 percent. This is still a better option than home equity since they cannot come after your house if something happens and you cannot pay it.
It just feels so risky…the thought of losing my home is enough to cause me endless sleepless nights. Even reading this article is enough to give me the scare! I dont know if taking out of home equity is going to solve the problem….dont you have to pay extra for the fees of arranging for that loan? I mean it comes with a price tag attached too. I probably eat ramen noodles for months to tackle this…I doubt I can swallow anything else.
It sounds good on paper about settling your consumer debts this way…but in reality our habits is what needs a shift. Saving money is really about sacrificing certain things. It is not only about being frugal but also about reducing the standard of living to meet our goals.
Well, I agree for the most part, except where you state that credit card debt will not put your house at risk. Credit card debt, when it leads to bankruptcy, almost certainly puts your home at risk. Provided you file (and are able to file) for a Chapter 7 liquidation, your home may be liquidated to pay-off your home loan, and any other credits you have. Does this happen often, no. Credit card companies recover more outside of a liquidation bankruptcy than in a liquidation bankruptcy (hence the recent bankruptcy “reform” which makes it much more difficult to file a liquidating Chapter 7). All credit places your assets (all your assets) at risk.
Man, 9 years to pay off your credit cards. You should do the math on how much you paid over time for that 16k. I’m sure it’s over double the cost.
At that point you realize a $100 jacket in 1997 ended up costing you $250 by 2007.
It’s never a good idea to borrow money on your home to pay off debt.
The root word of consolidation is CON.
The majority of people who consolidate INCREASE their total debt, not decrease it.
Debt and interest rates aren’t the problem, they are the symptom of a lack of control. If you want to get out debt, you have to take control of your life.
The biggest problem with a HEL(OC) is when the bank allows you to borrow more than your house is worth and then you need to sell it (thanks Countrywide).
Let me join the chorus — if you are not doing as the author of the post says and cutting up your credit cards (literally or practically so), this is anything from stupid to dangerous. Calls to credit card companies can frequently get you a lower rate as well, which can help. But using a HELOC to pay down unsecured debt is something that should be done only in the rarest of cases — you are sure your income is stable, you are changing (or even better yet, have successfully changed) your spending habits, and you are focused on debt elimination as a goal. Miss any one of these and we’ll all be coming by to admire the size of the hole you’ve dug for yourself. 🙂
I couldn’t agree more. I was tempted at the thought of taking out a home equity loan when I co-sign a refinance on my mom’s rental. But there is no reason for me a)to risk her financial integrity and passive income source and b)why I can’t just pay my debt off the old fashion way – over time, suffering with the rates that the companies will give me, growing passionately vengeful with every dollar interest that I pay. Thats really the only thing that will keep me out of debt in the future!
JD is just suggesting an option.
If you are teetering on the brink of financial collapse then this strategy is probably not a great idea. If you have an affordable mortgage and adding your CC debt to it won’t cause any problems (and you rip up the cards) then it’s a good option to consider.
Mike
I have to agree with most of the posters here (and Jim at Blueprint) that it’s a very bad idea to collateralize unsecured debt with your home, especially considering current economic conditions.
If you take out a HEL(OC) and your home loses value (which is happening now), you could end up upside-down on your house.
That being said – I used to do a lot of these loans, about the same time that JD was doing his re-fi. It can work well if you stick to your plan and cut up the plastic (and don’t use 100% of your home’s equity).
Personally, I am a big advocate of the unsecured consolidation loan. They are more difficult to get if you have less than stellar credit, but someone who pays all their bills on time can get a very good unsercured fix term loan rate from their local bank.
Home equity lines of credit are best suited if you’re not going to use them IMHO. They can be a great tool to have in case of a financial emergency (loss of employment, health, etc).
I do congratulate you on paying off your debt and having the disipline to use your heloc responsibly.
Getting into debt is easy, getting out is much tougher.
FourPillars wrote: JD is just suggesting an option.
Yes. Exactly. I am not recommending this, just presenting it as a possibility. I’m actually drafting a piece on other options to post later today.
Sounds similar to consolidating your debts into one loan. Sure, it makes things more simple, however you’re just shifting your debts to another source. Worse, you could have the illusion of hiding the debt.
We have actually done this, shifting debts to our home for a lower interest rate. However, we’re VERY careful to realize that it’s still debt! Discipline is definitely key. Waking up every morning to see that roof over your head is a good reminder.
I paid off my boyfriend’s HELOC in order to clear the lien against his house. He was paying 7% on 11k while I was earning about 1% in a money market account. No brainer.
We just sold the house yesterday and I wonder if not having the HELOC against it helped it go faster.
Sorry – I haven’t had the time to read the comments, but I know that home equity loans are a lien on your mortgage, and so are second mortgages, and I’m completely against them. Ditto for HELOC’s. One should have an emergency fund instead. Banks, collect the interest and are the ones who are benefitting, not the consumer. Putting your home at risk? — no way.
This is a question for the group.
I have a variable rate $40k home equity loan, which I got a few years ago against my co-op (to consolidate CC debt). Chase now holds the loan after they absorbed all of Bank of New York’s accounts after BNY closed. The initial rate is over and now it’s up to 9.25%, at a monthly cost of $325.
I’m in the process of applying at four banks for a better rate. HSBC’s offer is 8.7% for 20 years, Washington Mutual’s offer is close to 8%, First Fidelity offers 6.99% for 15 years. Citibank’s offer seems the best so far: An equity line at 7.25% for 30 years, no fees, no closing costs, with an interest only loan. These banks shave a +/- a quarter point if you open a checking account with them. Two banks that I went to don’t do co-ops.
I have a credit score of 800. I approached Chase for a better interest rate, but instead they came back to me twice with an offer for a brand new $100 k equity line at not such a good rate (7.7% + $50/year fee).
My plan is to go back to Chase today with the other banks offers and threaten to switch banks entirely if I don’t see satisfaction.
Anyone have any other advice? Am I going about this the right way? What can I expect to get in this current economic climate? Are there other banks that might be better to try?
No Bad Idea. What you will do is put an unsecured debt on your house and you never want to do that. You would be bteter just to work up a plan and pay off the cards or if you must transfer the cards to a low rate card and pay it off as fast as possible. The reason you do not want to put it on your home is what if something happened and you lost your job or got hurt (car crash, etc) and could not work. If you do not pay your credit cards then it just messes up your credit but if you don’t pay your equity loan or mortgage they will come take your house. Or what if you don’t change your spending habit you pay off the cards with an equity line and then run the cards back up. That happens all the time.
I think that home equity can be agreat tool, but it requires discipline and can easily be abused. As to losing your house, not being able to pay your bills can lead to the same problem.
If used correctly your home equity can cut your payment and shorten your pay off period while giving you a much lower after tax rate.
But I do agree with some of the comments, it doesn’t always work this way in the real world. I’m a mortgage banker, and it was too common that I would work with a client and help them restructure their debts with a refinance or home equity loan. A year later I would get a call that they needed to do it again. This could work when home prices were increasing so quickly. It looked for a while like there was a free lunch, but the tab is coming due now.
_If_ (and it’s a big, big if) someone is disciplined enough to not accrue any more debt, and they can make the monthly payments with a plan to use a HELOC to pay off their credit cards, yes, it can work. However, if they were that disciplined, it’s unlikely they’d have gotten into such straits in the first place! So count my opinion towards not using such a plan for most folks in this situation.
If you can be more financially responsible and savvy, as well as successfully reign in your spending ways, using home equity loans to pay off high interest unsecured debt can be a worthy idea. It’s most definitely not for everyone though.
It’s like using credit cards – using them to begin with requires discipline and a responsible attitude.
-Raymond
JD,
Just to give you a grin – The Onion wrote a story in 2002 about the US taking out a consolidation loan.
http://www.theonion.com/content/news/u_s_takes_out_debt_consolidation
Downward spirals of revolving credit should be viewed as a cancer (I’ll be sensitive to people going through real cancer, and let you piece together the details of the metaphor). Taking HELOC or Home eq loans is chemotherapy. You aren’t clear until you’ve paid off both, and you can won’t kill the disease until you stop the spending.
What you are actually doing (indirectly) is saying “I _will_ pay off these credit card debts, and I’ll give you my house if I don’t.” That’s a safer bet for the bank, so you get a lower interest rate. The trick is to avoid looking at this as a cost saving measure, this only works if you’re treating the disease in addition to the symptoms.
As far as canceling credit cards, you only slightly ding your credit, but your debt to credit ratio gets considered on it’s own (in addition to your credit rating number) when you get home loans, so it can cost you money if you’re debt/credit ratio is high when you apply for a home loan or refinance your home loan. If it keeps you from the temptation, then more power to you.
I folded credit card debt into a home mortgage once. I just went out and ran up the credit cards again! This was because I did not change my spending behavior!!!!
The day that I chopped up my credit cards and refused to swap debts back and forth between credit cards and home equity loans and debt consolidation loans was THE DAY that I stopped incurring new debt.
Fourteen months later, I was debt-free except for the house. I have been debt-free ever since (3.5 years!). In just three years, my house payment will be gone too.
All because I actually changed my spending behavior in 2002 and STUCK TO IT!
Remember this is a tool. It can be used wisely, it can be abused.
If you have gotten on the debt repayment system and have not been using or have cut up your cards, you feel confident about your job, you don’t take out the max of your available equity, you plan on staying in your home for 10+ more years, it can easily be used to consolidate or even be used to put down a payment or buy your second home, etc.
Just like other tools they can be used for good or for evil 😉
“The root word of consolidation is CON.”
Actually, the root word of consolidation is solid. Con- is the prefix. 🙂
Sorry, couldn’t help myself.
@ Iain – What kind of term are you hoping for? I would take the Fidelity offer. Termed out at 15 years, your monthly payment would be around $360, barely more than you pay now and you’re out from under it in 15 years.
No sense in amortizing that debt over 30 years unless you’re planning on never paying that debt off. If you take the Citi offer, you will be paying $240 a month in interest alone and never touching your principal.
Unless, of course, you mean to just transfer the debt to a new home when/if you move – then go for the 30 year interest only loan and enjoy that $240 interest payment indefinately.
Either way, you clearly don’t need more debt. Chase is making you that $100k offer becuase they know your spending patterns: you pay on time and carry lots of revolving debt. You’re their ideal customer. I wrote a post on how credit card companies do this yesterday.
Clearly you’re all dumbasses. If you can qualify for a HELOC surely you can qualify for a new credit card, and CC debt can easily be balance transferred to new cards at 0% interest. That’s 0% without putting your house on the chopping block. Surely anyone with even a half modicum of a brain can see this is a better way to go?
I know this post says it is about Home Equity Loans, but really its about borrowing money or using credit. This statement stuck out to me:
“Live without credit. Yes, you may need to buy a car on credit, but otherwise refuse to take on new debt.”
I agree with the first, live without credit, and the last, refuse to take on new debt. I argue the second part, where one might need to borrow money to buy a car.
Really great cars can be had for $3000-$5000, especially when buying from private individuals. Many brand new cars lose that much just driving them off the lot. Remember that when you leave the lot in your brand new car, its now considered “used” to any dealer. At least, to any dealer who wants to stay in business from buying and reselling used cars ;).
The average car payment according to the Auto Dealers Association of America sometime this summer was around $584/mo for 84 months. It doesn’t take a math genius to calculate that by avoiding car debt and saving that car payment each month, one could save up to buy a decent $3000 car in just 6 months. Or save for a year and buy a $7000 car. There’s a lot of really nice late model cars (even some low end models of luxury brands) that can be had for $7000.
It just takes a little discipline to change personal finance habits. Do you have what it takes?
If you have no current plan for reducing your current debt and are still living off of your credit cards then I say NO WAY. I was also one of the foolish people who eliminated all my debt into a 130K Home Equity Loan (school loans, cc debt, cash out for emergency fund) before I changed my behavior. It is like going on a crash diet and thinking you can keep the weight off long term. After a few vacations & bad investments, the secure feeling went away my cash was used up and your debt crept back up. Now that I have gained a little financial maturity and discipline, I would still most like never take a House Loan out until I am debt free. Snowballing my debt is much more rewarding each time I reach another milestone. By the time I finish paying it off in 10 years. I know for sure the debt will not be coming back.
I completely agree that no – you do not have to take out a loan for a car. People let their egos get in their own way sometimes, and they pay that price with debt. I purchased 2 very good quality used cars, both w/only $30,000 miles, for $5,000 each, cash. And I’m debt-free, including mortgage, and there’s no way that I would take out a home equity loan or heloc. I would do it if they let me have it for 0% interest (ha-ha) – otherwise no.
I think that taking out a HELOC can be a great tool to getting out of debt if you’ve already truly made the mental steps to do so.
J.D., was this your loan or for both of you? I know you’ve said before that Kris has always had good money skills and you keep separate finances, so I wondered how this worked out.
Plonkee, the loan was just for me. Kris had to sign the documents, and she was legally liable, of course, but those are the only roles she played in the process.
Well the good news is it’s next to impossible to get a home equity loan these days unless you have some serious equity in your home, so that’ll make the decision easier for most homeowners.
@Heidi. Re: 15 years vs. 30 years to pay back the loan.
Thanks for the input. Yes, it makes a lot more sense to spend almost the same amount to pay it off in half the time!
Just an anecdote where I think a HELOC or HE Loan works. I married this year, and my wife had been paying a credit counseling company $30/month to send her credit card payments in. (Biggest waste of money IMHO) Also, she had some other private student loans with high rates. With our combined income, though, we could tackle these loans very well and we applied for a HELOC on my house to consolidate for a low interest rate. We have paid down a $50000 debt into about $25000 this year, and are working it down very quickly. It helps that I’m a very disciplined cash manager, and so far she’s bought into my plan. We have less spending cash available now, but every month when I see the debt go down more and more it makes me feel great. Also, we chose HELOC because the rates are variable and in the foreseeable future, they will trend downards.
I convinced someone I know NOT to do this. She has a lot of credit card debt at high interests but I told her to wait and see if she could put a dent into her credit cards before going the HEL route. The main reason is I think when it is easy, you don’t really learn anything. She recently told me she’s been doing really well paying down her credit card and shifting the balance to lower interest deals.
I agree, HELOCs are great tools to use in consolidating debt, provided the consolidator is financially responsible, or ready to become so. Also, most people don’t realize, but there are a few clever methods that practically anyone can use to significantly decrease their monthly HELOC payment. One is to use their HELOC as their primary checking/savings account. There’s really no reason not to. You can use a HELOC check or debit card just like you do a checking/savings account check or debit card. By using the HELOC as your checking/savings account, you let all that money offset interest in your HELOC instead of doing nothing sitting in your checking or savings account.
That’s just one way. There are several more that are just as easy and just as effective, albeit a bit more creative.
The home equity loan proved to be a trap for us. We did it, and because we were not required to cut up our cards and close the accounts, we quickly ran the balances up again. When we sold our house we lost almost all the equity by paying off both mortgages, and the new credit card debt. We’ve run it up again, and are maxxed out. We are living check to check, and the calls from teh card companies are coming in since we often end up a bit late.
Fortunately, I have some windfall coming in April and may and with it I will pay down a goodly portion of my debt. The last 6 months of endforced living without credit have taught us a new way of living which we must carry over once the debts are finally paid again. If we make it that far… March is going to be the toughest month of our lives, ever. I would not wish this kind of hell (and I don’t use the word lightly) on anyone.
If we make it to April, we will emerge from this very grateful, and can begin a somewhat normal life once again, which will get better once we can start keeping and seeing some of the the fruits of our labours. The best part will be an end to the phone calls!
This dry spell in my business combined with my excessive debt has brought my FICO score down to 576. Frankly I don’t care since i will try to forgo credit altogether once we break free. We are at the point where, because of my FICO score, the Credit card companies have been telling e I don’t qualify for a reduction in interest rate! The people who need help the most are the ones who don’t get it.
I say without reservation that the worst mistake I ever made was getting a credit card.
Well I used to sue people that didn’t pay their bills and was a cleolctor so I have a little knowledge about consolidation. It is good you don’t want to go through CCC because they take about .75 cents of every dollar you give them. If you own your home you could try refinancing to get some money out or a home equity loan as it will have lower interest than your CC’s. Depending on how good your credit it a consolidation loan could be a good option, ask your bank or try a credit union to get the best rates. You can also call your credit card companies. Most will work with you if you let them know before you go delinquent. I had an MBNA card that I let get too high and couldn’t pay anything but the minimum, I was 18, first card. They gave me 0% interest as long as I made my monthly payments but they closed the card. They also bumped up my monthly payment to $30. I ended up paying it off with a little help from taxes but I didn’t have to pay interest. Your best bet would be call your CC companies and see if they will lower your interest. If you want one payment then try for a loan.
Home equity line of credit are great tools to have and yes maybe a good idea to use it when trying to pay off credit cards with higher rates. But people should still be careful with them