Should I Take Out a Home Equity Loan to Consolidate Credit Cards?

If you’re like most Americans, you have some sort of credit card debt. If you’re paying upwards of 10% and even 20% on those credit cards, then chances are you aren’t making much headway when it comes to paying them off.

Turn on any TV or pick up any newspaper and you’ll find the home equity loan or HELOC (home equity line of credit) market is directly targeting consumers strapped with high-interest credit card debt.

The upside? Most home equity loans or HELOC’s run between 7% and 9%, a much better rate than the 18% to 21% of store credit cards. This alone could save a consumer hundreds to thousands of dollars over the life of a balance. Up to $100,000 of home equity loan interest payments are tax-deductible. Minimum payments are usually lower, and principal is paid down much faster.

The downside? Your debt is now tied to your home. If you default on the home equity loan or HELOC, you could lose your house. For anyone with even a slight tendency towards undisciplined use of credit cards, consolidation through home equity may be disastrous. There are usually closing costs associated with these types of second mortgages, so don’t forget to subtract those amounts from any interest saved.

Before you make a final decision, consider the following factors.

How much will you actually save on interest? There are a multitude of financial calculators on the internet to help you determine what you will pay in interest over the lifetime of a credit card balance. Compare this to what you will pay with a HELOC or home equity loan. Don’t forget to factor in closing costs such as loan application fees, appraiser fees, mortgage filing taxes, etc.

How much do you owe? The general rule is to consolidate at $10,000 or more, but simply transfer to cards with lower fixed rates if your balance is less. If you have reasonable credit, you can usually find credit cards with lower fixed rates and transfer your balances. Even if you have to re-apply for new cards every nine months to a year, it will be worth the effort.

What caused your credit card debt to begin with? If it was a one-time expense such as college tuition, medical emergency, job loss or wedding—and you’re generally good about living within your means—then debt consolidation is probably an excellent option.

If your credit card debt stems from trips to the mall, a big-screen TV, a cruise and lots of other stuff you don’t even remember, then chances are consolidation is NOT a good option for you. Regardless of your balance, you’ll be better served transferring balances to lower-rate cards.

Regardless of what you decide, make sure to read the fine print on all home equity or credit card offers. Look for fees and closing costs, and factor them into your decision. Avoid the urge to “medicate” your debt pain by making hasty decisions. Take a few days to mull over offers you’re considering.

Either option will save you money and start you down the road to debt freedom, so examine your options, make your decision, and get started!