ICFE eNEWS #16-05 - March 1st 2016
"Credit Card Debt & Home Equity Loans"
By Jim Garnett, a/k/a Ask Mr.G, a member
of the ICFE's Board of Educational Advisors
Should you take out a home equity loan to pay off your high
interest credit card balances? Find out what the Debt Doctor thinks.
In 2015 over one-third of all American households carried some
sort of credit card debt. ValuePenquin reports that those families
who carried over their card balances from month-to-month averaged
a total credit card debt of $15,779.
This presents a large
market for financial lenders to target those families with ads promoting
the practice of using home equity loans to "pay off high interest
credit cards." Their selling point is that the interest rate
will then be less, plus the interest will be tax deductible.
To make sure we are on the same page, remember the equity in
a home equals the difference between the outstanding mortgage on
the home and its current market value. If I owe $200,00 on my home,
and its appraised value is $240,000, I have $40,000 equity that
can be used as security for a loan.
On the surface this practice
may sound like a good idea, but as you know, not all good sounding
ideas are good, sound ideas. We must consider more than just the
interest rate and tax benefit. There are negative factors to this
practice that might well outweigh the positive benefits. See what
First of all, borrowing against
our home to pay off credit card debt, does not actually "pay
off" debt. The amount of debt remains the same, but is "transferred"
from one location to another. Credit card debt decreases, but in
the same proportion house debt increases. The process is similar
to digging a hole in our front yard in order to fill in the hole
in our back yard. You end up with the same amount of hole, just
in a different location.
So, don't be confused by the jargon,
borrowing to "pay off" debt does not "pay off"
anything. It merely moves it to a different place. Knowing this
allows us to determine if we would rather have debt on our credit
cards, or debt against our home.
when we transfer debt from our credit cards to our home, we are
turning unsecured debt into secured debt. If we get behind on credit
card payments, we can lose our credit, but if we get behind on our
home equity loan, we can lose our house!
Home equity loans
are much less risky for the financial lender because it is secured
with the house itself. That's what makes the rate of interest less.
It usually is on secured loans versus unsecured loans. But what
is less risky for the lender is usually more risky for the borrower.
Therefore, it rarely is a good idea to turn unsecured debt into
Thirdly, statistics are pretty
clear that this practice does not work in that it does not have
a good outcome for the borrower. Within a span of three years, the "paid
off" credit card debt has grown back to the size it was previously,
primarily because there is no change in the spending lifestyle that
caused the problem in the first place.
The zero credit card
balances create an illusion that "the problem" has been
fixed, and the person assumes his practice of using credit cards
and not paying off their balances each month.
Tapping into our home's equity can create problems down the road
for many people. Here are three problems it creates:
1. Reappearing Debt. The credit card debt normally
reappears within a few years because the cards are not canceled
and continue to be used.
2. Reduces Options When
Selling. Loading more debt against our home can backfire
if and when we decide to move and sell our home. We will have less "wiggle
room" in our asking price because we have to ask enough to
pay off the increased mortgage. It can also result in having little
or no down payment to put toward the new home.
Restricts Retirement. It can be more difficult to retire
if we have still a monthly house payment to make. This has caused
some to postpone retirement or, at the least, have to continue working
part time. There is more involved than just interest issues when
considering a home equity loan to "pay off those high interest
credit cards." Doing so can be better for the lender, but not
necessarily better for the borrower. So, proceed with great caution.
© Jim Garnett, The Debt Doctor
AskMrG Consulting, LLC
2216 SW 35th Street
Ankeny, IA 50023