Don’t Use Home Equity To Pay Off Unsecured Debt

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Burning HouseThis is a dueling bloggers post between me and JD of Get Rich Slowly. Read his post on Using a Home Equity Loan to Pay Off Credit Cards and share with us your thoughts on the issue!

So you’ve racked up a little bit of credit card debt and you’re trying to find a way out from under the interest payments so you can make some headway. You’ve considered a few options and now have settled on tapping into your home equity to give you some breathing room – a lower interest rate and the deductibility of those interest payments. Before you transfer that debt over, let me give you a few warnings and then some alternatives that may be more attractive.

First things first, by home equity I mean tapping into a line of credit or a loan against the amount of your home that you actually own. Home equity is the value of your home minus the current balance on your mortgage and is a representation of how much value you possess in your home. When you go to the bank for a loan, they may or may not send out an appraiser to assess the value of your home to determine this number. The home equity loan will use your home as collateral against the loan, meaning if you can’t make payments they will seize it and auction it off.

The primary reason I don’t advocate the transfer of the debt from an unsecured credit card to home equity is because of the downside. If something catastrophic occurs and you are no longer able to service the debt, having it be tied to your house is much worse than having it be tied to an unsecured credit card. If you can’t make payments on your credit card, there’s very little they can immediately take away from you as a matter of process. If you can’t make payments on a home equity loan, they can seize your house and sell it. That’s because your home equity loan is backed by your home as collateral, that’s the reason why the interest rates are so much better (they take on less risk for loaning you the money).

Another reason against transferring the debt from credit cards to your home is that it doesn’t address the underlying root problem (this is for cases where the debt is the result of runaway spending, if you have the debt for reasons outside your control like medical expenses or unexpected emergencies, feel free to skip this paragraph). Your problem isn’t that you are having trouble with the payments, your problem is that you can’t stop spending. What you need to do, if you haven’t already, is to take steps to curb your spending. Whether that’s freezing your cards in a block of ice or cutting up your credit cards, you need to address the underlying problem. The danger of transferring your debt to more favorable terms and not addressing your spending is that you fix a symptom but expose yourself to much greater danger. You’ve just given yourself more rope to hang yourself with and this time you run the risk of losing your house, not just access to credit.

Lastly, there is a psychological reason for keeping the interest rate – it keeps the debt in the forefront of your mind. When you consolidate it into a home equity loan, it starts losing its significance. This is especially true if it’s a HELOC (home equity line of credit, where you have a standing line of credit similar to a credit card) and you have other projects tapping that HELOC as well. By keeping it in the “credit card realm,” you have a constant reminder that you have this debt and you have to fight like crazy to get out from under it. This is a purely psychological reason and goes against the math.

So, if not home equity, where? Keeping unsecured debt as unsecured debt while reducing your rate is key. I can think of two great options that you should consider instead of putting your house at risk:

Other credit cards! Credit card companies love revolving debt and will be willing to give you a great teaser rate in order to get you to sign on. I know a lot of people who have taken advantage of 0% balance transfer offers as a way of catching up. Now, the risk of transferring this debt to another card is that you still don’t address the underlying root problem of spending (if that’s the case), but you would need to address that regardless of the steps you took to reduce your interest rate. Going with another unsecured line of credit is significantly better than a secured line because you don’t risk your collateral if you do slip.

Prosper! Depending on your credit, Prosper is another great location to go to get unsecured credit to help you pay down your bills. You’ll have to check your credit to see what the representative rates are for your credit score but I’ve heard good things from debtors about Prosper. I’ve personally never done this so I can’t speak to it but Tricia at Blogging Away Debt has and you can read about her experiences with Prosper.

(Photo: dvs)

{ 12 comments, please add your thoughts now! }

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12 Responses to “Don’t Use Home Equity To Pay Off Unsecured Debt”

  1. Just ask the credit card company for a lower rate. They will give it to you if you are polite. This has worked 9 times out of 10 in experiences I have had with financial counseling. Ask for 0% and they will counter with something reasonable.

  2. TTFK says:

    Hallelujah! I’ve been telling people for years that converting unsecured debt into secured debt is right at the top of the no-no list, and they look at me like I grew a 3rd arm out of my ear.

    If it all hits the fan, dealing with collection agencies and 7 years of credit hell is MUCH more preferable than losing your home!

  3. Minimum Wage says:

    I promise I will not use home equity to pay off unsecured debt.

  4. I see JD’s point that it is an option, but way too risky for my taste!

    Plus you make a great point about the psychological impact of high interest rates. I take it personally and make it my mission to get out of debt in spite of the card companies. I’m at a point where I’ve done EVERYTHING short of home equity loan to improve my situation. (Balance transfers, Prosper, second job, endless phone calls to customer service reps that will no longer budge…) Time to accept the crappy rates get rid of the crappy rates by paying down balances ASAP!

  5. Peter says:

    I’ve seen getting a Home Equity loan cause folks to crash and burn, and help others to regain control of their finances from sudden financial setbacks. I think the problem is being honest with yourself in how you’ll really use it, and really have a plan to pay it back. In the context of this article, it’s a delaying factor to buy time, not a fix.

    One point I don’t necessarily agree with, is if you screw up and can’t pay it back, sure they can go after your home, but if you’re in that kind of shape, chances are you’re not going to be paying the mortgage either regardless of the methods you’re using.

    Personally, I like the 0% interest offers. I’m currently using this to help me gain control of my credit card debt. I’ve rolled the balances over three times so far and have cut the debt in half. The offers usually start flooding in between now and February. One point on these offers, be very careful because even with good credit, the fine print allows them to do three things. The first is not give you 0%, but rather some lowerer number, e.g. 3%, based on your credit history/rating. Another is that they may not give you a sufficient credit line to cover the whole amount you’re asking for and finally they may require you to actually use the card, or they’ll start charging you some rate of interest.

    I had the last two mentioned happen to me. They only approved a credit line for 3K of the 8K I was asking for, and they wanted me to make at least one purchase per billing cycle after the first 60 days to keep from triggering their changing the terms to charge me interest. So I had to get a payment in right away, and then make a small purchase with the card in the next billing cycle, because if you go over their limit, that also triggers the charging of interest and of course, a fee. Fortunately the second card I used to cover the 5K they didn’t had none of these issues associated with it. Guess which card I’m still using.

  6. I actually prefer to do the opposite and use credit cards to pay off my Heloc!!

    • David says:

      A GREAT idea & one I hadn’t thought of!!!
      How can you do this & WHAT cards do you recommend?
      Thanks, David

  7. icup says:

    Regarding ‘other credit cards’. There is no such thing as a 0% balance transfer any more. “HA!”, you say, “You’re wrong! I just got one in the mail today!”. Well, read the fine print. You get 0%* interest, * = 3% transfer fee applies ($5 minimum, NO maximum). So all that means is you are paying the 3% yearly interest fee up front.

    Of course, 3% is still better than 18%. I’m not arguing that. I just wish they would call it what it is. Its not a 0% transfer. Its a 3% transfer. Which is still better than a 6% HELOC by the way, no argument there.

    I’m not criticizing you by the way, I’m just ranting against the shady tactics the cc corps use.

  8. jim says:

    icup: there are still no fee 0% balance transfer out there, the citi professional card is one example. It lists the fee but says “waived with this offer.”

  9. icup says:

    @jim, actually that is a good deal too because it has a $50 maximum, so anything you transfer in excess of $1600 would lower that percentage rate below 3% if they weren’t waiving it.

    But those offers are few and getting fewer. I have good credit, and could probably get this card if I applied for it, but the ones I’m getting in the mail have been mostly the no-cap 3 percenters with a couple of $99-cap 3 percenters thrown in for good measure.

    Good find though. Almost makes me wish I had something to transfer to it to take advantage of cheap money. Almost.

  10. jim says:

    icup: you are right though that the offers are getting fewer and fewer, i bet the subprime lending issues are having an affect on that. what’s nice about citi is that you can just have them cut you a check, then do balance transfer arbitrage.

  11. ningpo says:

    “It’s only meant for individuals that can handle credit and debt responsibly. “, oxymoran, springs to mind! our math is ok, but aren’t we losing sight of the ‘problem’.? the question is how can we increase our discipline muscle and get support to do that? the math is easy and we all are in a different situation so we’ll leave that up to the individual. NOW, what’s the purpose of the blog, great title, but to the right and the left are ads tearing at our very financial roots! is this really what we want on the same site? success, another questioning searcher … ::-)

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