San Diego, CA. Bad Idea To Use Home Equity to Pay Off Credit Card Debts Homeowners, nationwide are the targets of an onslaught of advertising urging them to trade in some of their home equity to pay off their credit card debts. Many homeowners want to know if this is such a good idea and if not, why not.
The ICFE put this question to Jim Garnett, a member of the ICFE's Board of Educational Advisors. Jim serves as the Education Coordinator for Consumer Credit of America, a/k/a Consumer Credit of Des Moines, both based in Iowa. He is a nationally certified parent trainer with the Smart Discipline Seminars.
ICFE: Should a home equity loan be taken out to pay off credit card debt? The main benefits being the interest rate would be less and the interest tax deductible.
Jim Garnett: The benefits you site are true, but there is more to consider here than the interest rate and tax deduction. I am convinced the negatives outweigh the positives in this practice. Here's why:
First, borrowing against a home to pay off credit card debt is not actually paying off debt at all. Debt is simply being moved from one place to another. In this case it is moving the debt from your cards to your home. "This is like digging a hole in the front yard in order to fill in the hole in the back yard! But, there's still a hole!"
Second, this practice changes the debt from an unsecured debt to a secured debt. This may be good for the lender, but it is rarely good for the borrower. The home is now at risk because it serves to be security for the loan. In a worse case scenario, the borrower could no longer discharge this debt under bankruptcy without losing the home.
Third, statistics show that when people borrow to pay off credit card debt, the credit card debt grows back to where it was within two-and-a-half years. This is because borrowing to pay off debt requires no change in spending habits and they continue to create new debt.
There is a better way to pay off credit cards than borrowing against your only nest egg, your home.
Here is a four-step plan:
(1) Discover what your monthly cash flow is when you do not use credit. This is found by subtracting an average month's spending from an average month's take home (not gross) pay. You may need to track your spending for a month to really see where your money has been going. If your spending is more than your net income, you must spend less or make more.
(2) Determine that you can afford to buy only what you have money, not credit, to buy.
(3) Decrease your number of active credit cards to one or two cards, cancel the rest, and pay the active cards balances off each month.
(4) Discipline yourself to look at your credit card debt as one debt with one payment, and keep that payment the same until the entire debt is paid off.
If the total credit card debt is $8000 and the total of the minimum payments add up to $250, keep paying the debt off at $250 a month. When a card is paid off, transfer that payment to another. This will enable a pay-off of $8000 of credit card debt in about 5-1/4 years instead of the normal 25 years, and save nearly $7500 of interest!
Avoid the quick solution of borrowing, especially against your home, to pay off credit debt! It rarely works. It becomes a never-ending cycle. The better plan is to realistically see what is affordable, reduce the want list to "needs only" and restructure debt payment until it is gone.
If you have a question for the ICFE Board of Educational Advisors, please visit www.icfe.info. @ www.icfe.info.