Is it Smart to Use A Home Equity Loan to Consolidate Credit Card Debt?

For homeowners with established equity in their homes, using a home equity loan or home equity line of credit (HELOC) to consolidate credit card debt may seem like a good idea. After all, the interest rates on secured loans tend to be much lower than debt consolidation loans or credit cards. But there are inherent risks to consider before using a HELOC to pay off debt.

Related: Home Equity Loan for Debt Consolidation

How to use a home equity loan to pay off credit cards

Before a homeowner decides to use equity to take out a loan or line of credit, it’s important to distinguish between the two. A home equity loan, also known as a second mortgage, is similar to a debt consolidation loan. The borrower receives a lump sum amount, then works to repay the fixed-interest rate loan at set installments until it’s fully repaid.

On the other hand, a HELOC is a revolving line of credit. That means the borrower can borrow however much they need up to a certain credit limit. Then, they can repay the borrowed amount as they are able without fixed interest rates or payments. Within the terms of the HELOC, the borrower can take out more as the available credit limit allows.

For this reason, borrowers need to be much more responsible when choosing to use a HELOC to pay off credit cards. Because there’s potential to get even deeper in debt, it’s critical to address underlying overspending issues before opening a HELOC.

Related: How does a HELOC work

Pros of using a HELOC to consolidate credit cards

Using a home equity loan to pay off credit cards certainly has its advantages, like:

• Interest rates are often lower: Perhaps the biggest pro to using HELOC to pay off debt is that the interest rate tends to be much lower than the average credit card. This may be especially true for homeowners with above-average credit scores.
• Mortgage interest may be tax-deductible: Come tax time, you may be able to deduct interest paid on the mortgage up to a certain amount, which would include interest paid toward the HELOC. But it’s always best to consult with a tax professional first to be sure, especially if you haven’t itemized deductions in the past.

Cons of using a HELOC to consolidate credit cards

There are also some cons of using a HELOC to pay credit cards, like:

• Borrowers risk losing their home: Since the home equity loan or HELOC is secured by the home as collateral, failure to repay what’s owed means the home could go into foreclosure.
• Credit card debt may be easier to discharge in bankruptcy: If you think you may be heading toward bankruptcy, it’s smart to talk to a financial professional who can advise whether it’s best to keep credit card debt as it is or roll it into a HELOC.
• Consolidation doesn’t address poor spending habits: Before consolidating credit card debt (whether using a HELOC or an alternative), you’ll need to address the underlying habits that caused the debt in the first place. Failure to change habitual overspending or poor money management means credit cards could be maxed out again soon after being paid off.

Alternatives to using a home equity loan to pay off debt

If you don’t own a home or aren’t willing to use your home as collateral to pay off credit card debt, there are alternatives to consider.

Balance transfer credit card

A balance transfer credit card can be a smart move for those whose credit score is high enough to receive the best interest rates. When comparing a HELOC vs. 0% interest credit card, it’s important to assess how much debt can reasonably be repaid during the 0% interest period. Otherwise, the HELOC may have an overall lower interest rate since credit card interest rates may skyrocket after the introductory rate expires.

Debt consolidation loan

Using a personal loan for debt consolidation is another option worth considering. Personal loans generally have lower interest rates than credit cards and tend to be best for those who want a fixed interest rate loan with a predetermined repayment schedule.

Debt settlement

The process of debt settlement can cause damage to your credit score. That’s because debt settlement generally advises stopping paying creditors to negotiate a lower debt balance. If these creditors “settle” to accept less than what’s actually owed, you can be off the hook for less money.

Debt management plan

A debt management plan is typically offered by a non-profit credit counseling agency. In addition to helping with fundamental financial concepts like creating a budget, a credit counselor can also help manage debt payments and even negotiate with creditors on your behalf to try and lower interest rates or payments.

Bankruptcy

Bankruptcy is often a last resort when it comes to credit card debt consolidation. That’s because it can have far-reaching implications for your credit score and ability to get on track financially in the future.

FAQs

Which is better home equity loan or line of credit?

The question of whether a home equity loan or line of credit is better depends on why you need the money. A home equity loan is a lump-sum payment paid back in fixed installments. So, it may be a better option for a one-time large purchase. A HELOC is a revolving line of credit where the borrower can use money, repay it, and use more as needed. This makes it a better option for an ongoing project like a home renovation that requires multiple purchases.

Is a home equity line of credit a secured loan?

A home equity line of credit (HELOC) is a secured loan that uses your home as collateral. That means if you fail to repay the loan in a timely manner, your house is on the line and could potentially fall into foreclosure.

Related: Secured vs Unsecured Loans