Homeowners might consider using their home equity to pay off credit card debt, given rising home values and mortgage rates often lower than credit card rates. But is it a good idea? The answer isn’t as straightforward as it seems.
Risking Your Home
Home equity loans or home equity lines of credit (HELOCs) leverage the equity in your home. Equity is the value of your home minus the balance of your mortgage and any other home loans. For instance, if your home is worth $350,000, and you owe $200,000 on your mortgage and $50,000 on a second mortgage, you have $100,000 in equity.
Home equity loans typically have fixed terms, rates, and payments, while HELOCs usually offer variable rates and flexible payments. Both options require good credit and significant equity in your home.
Because home loans generally have lower interest rates than credit cards, using your home as collateral to pay off credit card debt might save you a lot in interest payments. However, this comes with a serious risk: you could lose your home. Missing payments on these loans could lead to foreclosure, unlike missing credit card payments, which might result in late fees or higher interest rates but won’t put your home at risk.
The Danger of Upside-Down Mortgages
Another concern is a downturn in the real estate market. If your home’s value drops, the loans you owe might exceed your home’s worth, making it difficult to sell your home. Adding a second loan or HELOC increases the risk of an underwater mortgage during market declines.
Home loans often come with fees and closing costs, which can be substantial. Loans advertised as “no closing cost” usually have higher annual percentage rates (APR), incorporating these costs into the rate. These expenses might offset some interest savings, potentially extending the time to pay off the debt.
If you habitually use credit cards beyond your means, using a home loan to clear your balances might encourage further overspending. This could lead to accumulating even more debt, harming your financial health and credit score over time.
Alternative Ways to Pay Off Credit Card Debt
Fortunately, there are other strategies to pay off credit card debt:
- Prioritize Paying Off Credit CardsIt might seem challenging to use your current income to pay off credit card debt, but many people do it, and you might be able to as well. Two popular methods can help you get started: the Avalanche method and the Snowball method.
- Avalanche Method: List all your credit card balances and their respective interest rates, ordered from highest to lowest interest rate. Make minimum payments on all cards to avoid late fees and focus extra payments on the card with the highest interest rate. Once it’s paid off, move to the next highest, and so on. This method can save you money and help you pay off debt faster.
- Snowball Method: List all your credit card balances, starting with the smallest. Make minimum payments on all cards and focus extra payments on the smallest balance. Once it’s paid off, move to the next smallest, and so on. This method can provide quick wins and motivation by clearing smaller balances first.
- Get a Balance Transfer CardA balance transfer card with a low or 0% promotional interest rate can help consolidate multiple card payments into one and pay off debt faster. However, be mindful of transfer limits, promotional period deadlines, and transfer fees, which typically range from 3% to 5%.
- Apply for a Personal LoanUsing a personal loan to pay off credit card debt might be beneficial if the loan’s interest rate is lower and the monthly payments are manageable. This can consolidate multiple payments into one and make your debt easier to handle. Compare the total cost, including interest and fees, to your current credit card debt to ensure savings.
Pros and Cons of Debt Consolidation
Debt consolidation has its advantages and disadvantages, whether through a home loan, personal loan, or balance transfer card:
- Pros:
- Lower combined interest rate
- Fixed rates and terms
- Lower monthly payments
- Potential to pay off debt sooner
- Reduced interest expenses
- Freeing up funds for other financial needs
- Cons:
- Not paying off debt as quickly as desired or at all
- Not achieving expected interest savings
- Incurring fees
Consider Other Options
While using home equity might seem like a good way to pay off credit card debt, it involves significant costs and risks. Homeowners should consider other options, such as the Avalanche or Snowball methods, balance transfer cards, or personal loans, before risking their home to pay off credit card debt.
