Why Paying Off Debt with a Home Equity Loan is a Risky Strategy

Key Takeaways
  • Home ownership can provide an asset you can borrow against to consolidate debt.
  • It is rarely a good idea to consolidate credit card debt using your home as collateral.
  • You risk losing your home if you cannot make the new debt payment.
  • Credit cards offer fewer lender protections than a home loan, giving creditors the advantage if you convert unsecured debt to secured debt.

Almost everyone has debt. You use credit to purchase a home, buy a car, pay for college, and make everyday purchases on a credit card. When credit card balances creep up to the maximum limits, and you realize making minimum payments on thousands of dollars’ worth of debt does not move the needle, you seek faster ways to get out of debt.

When you own a home, tapping into the equity can seem like a good debt elimination plan. Home equity loans offer low-interest rates and long repayment periods. Before you apply for a home equity loan to pay off high-interest credit card debt, consider the risks of using the equity in your home as a debt solution:

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  1. Your home is the collateral: The very thing that gives you better rates and terms can also be the biggest risk. If you fail to make on-time payments on a credit card, the lender has nothing to take for repayment. When your home secures the loan, the lender can foreclose on your house if you miss payments.
  2. Acquire even more debt: When you transfer debt from credit cards to a home equity loan, you now have open credit lines on your credit cards. If you have not addressed the underlying money management or income issues, those available credit lines can result in newly maxed out credit cards, leaving you in significantly worse financial shape than you were before.
  3. Long repayment: Paying only the minimum on credit card debt can result in 30 years of payments to eliminate large balances, assuming you stop using the card. Transferring that debt to a home equity loan will save money on interest, but longer repayment terms can still mean you spend 30 years paying off the debt.
  4. Loss of legal benefits: Credit cards have the lowest repayment priority in bankruptcy, where home loans are at the top. Transferring credit card balances to a home equity loan, even in bankruptcy, will require full repayment of any outstanding balances if you wish to remain in your home. Had the debt remained on the credit card, a judge could discharge the debt, legally freeing you from the obligation of repayment.

Other legal channels for credit card relief include credit counseling, an unsecured debt settlement loan, or debt negotiation. Each of these channels offers resources for outstanding credit card debt, but not for home loans.

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When you use a home equity loan to pay off credit card debt, you are not actually paying off anything. Instead, you are transferring the debt or restructuring the debt. You still have the full balance to repay, interest to pay, and more risk if you fail to keep up with the payments. There are other, less risky, and more favorable options available. Some, like debt negotiation, do not require upfront funds, can immediately lower monthly payments, and do not require you to repay 100% of outstanding balances plus ongoing interest, lowering the long-term risk to your financial health.

  • Should I use my home equity to pay off credit card debt?

    A lower interest rate is the primary benefit of using your home equity to pay off high-interest debt. There are also two major downsides to consider. You will extend debt payments for up to 30 years, which limits the amount you will save, and converting unsecured debt to secured debt will put your home at risk if you can’t keep up with the payments.

  • Can I Transfer my credit card debt into a new mortgage?

    It is often possible to add credit card debt to the mortgage balance when you refinance. To qualify, you must have equity in the home and enough income to make the larger loan payment. Most lenders allow you to borrow 80% or more of the home’s value on your primary residence. A cash-out refinance does charge a higher interest rate than a refinance of the existing mortgage.

  • What is the difference between an equity loan and an equity line of credit?

    An equity line of credit acts like a credit card secured by your home. You can make interest only payments on the debt for up to 20 years before requiring you to pay down the balance. Home equity loans are a second mortgage. The rate is higher than your first mortgage and the loan has a fixed rate and term for up to 30 years. Obtaining a loan or line of credit on your home does not require you to refinance the first mortgage.