Reducing credit-card debt can be an important step on the path towards achieving your financial goals. For many homeowners, putting your home equity to work can be a good solution, and using home equity to reduce your credit-card debt is a smart decision. Consider these factors, if you might be planning to use home equity to reduce your debt.
Using Home Equity
Home values have enjoyed strong appreciation over the last several years. This means that many homeowners who bought at the beginning of the cycle are sitting on considerable equity beyond their down payment and loan principal payments. Other owners, who’ve been in their homes for years, are also in possession of considerable home equity.
Tapping into that equity to meet your financial goals seems like a smart financial move, and it can be in certain cases. With a cash-out refinance, home equity loan or home equity line of credit (HELOC), you could make valuable home improvements, go back to school for a better job, invest or pay down high-interest debt.
Saving on Interest
Reducing your credit card debt using your home equity will save you a lot of interest. Credit-card debt generally means double-digit interest rates, meaning you’ll pay a good bit more than you initially spent to pay off any long-term balances. You’ll still pay interest when you borrow against your home equity, of course, but home equity loans offer much lower interest rates, often with a fixed rate that won’t go up like the variable rate on your credit cards.
Consolidating Monthly Payments
Another benefit of tapping into your equity is that you can consolidate some monthly payments, with differing amounts, due dates, terms and interest rates, down into one, single monthly payment. This can reduce the hassle of staying on top of many different debts, and it could also save you money. If you miss one of your several credit card payments, you’ll get hit with a late charge and could see an interest rate increase or a ding on your credit. However, as long as you can reliably and consistently keep up with your home equity loan repayment, you’ll avoid that problem.
Planning for Debt Management
It’s very important to take a good look at your financial situation before trying to pay down debt with equity. A big part of becoming debt free is understanding how your credit-card debt was created in the first place. This is necessary so that you can plan for better debt management, now, and in the future, if you do go ahead with an equity loan.
Avoiding New Debt
Debt created due to a past illness or job loss could be a good case for tapping into your equity. However, debt created by overspending or a lack of budgeting or saving is another matter. By using your home equity, you’ll be paying off the debt you’ve already accumulated, but your home equity loan won’t protect you from future credit-card debts. So it’s important to make a plan to carefully manage your finances so that you avoid new debt after using your equity.
Putting Your Home on the Line
Another factor to consider is the difference between secured and unsecured debt. Credit cards are an unsecured form of debt. Keeping up with payments, paying late fees, and possibly enduring collection calls or damage to your credit score is not fun, but it won’t cost you the roof over your head. This is not the case with a home equity loan. Mortgage loans are a type of secured debt, with your house being the collateral backing the loan. If you decide to tap into your equity and get behind on the payments, your house could fall into foreclosure. If you’re considering a home equity loan, it’s important to make sure you always stay on top of your new loan payment.
Considering Closing Costs and Loan Terms
Don’t forget to account for the cost of accessing your home equity. While rates, terms, and fees can be more favorable than those of credit cards, these costs are something to weigh in your decision.
You’ll pay closing costs on a home equity loan or HELOC, which means some of your equity will go towards these fees. The total cost of these fees will depend on your specific situation. Also, many HELOCs come with a variable interest rate. That could mean paying more in interest than you initially planned for if rates go up. For such a solution to work as a debt consolidation tool, you’ll want to find a HELOC with a reasonable lifetime rate cap and plan on making principal payments from the start to reduce costs, or go with the fixed-rate option of a cash-out refinance.
Many homeowners are sitting on considerable equity, but they most likely also have considerable credit-card debt they’d like to pay off. If you’ve got equity built up in your home, why not use it to your advantage? Using a cash-out refinance can consolidate your debts, reduce the number of payments you’re making each month, and maybe even raise your credit score while saving on interest.