Pros and Cons of Paying Off Credit Cards With Home Equity Loans

Equity costs less than credit so financing a credit card debt with equity is cheaper. However, there are a few cursory related issues such as capital for home improvements, amount of credit card debt, and refinancing that can make the interest rate benefit not worthwhile.

This article will discuss the various advantages, disadvantages and factors that may assist with the decision to pay off credit card debt with home equity, and then follow up with a few tips that may prevent one from having to use home equity to pay off debt.

Advantages

The larger the credit card debt, the more practical a home equity loan becomes once all other options are deemed unavailable. In other words, if there is no other cost saving solution, a home equity loan may not be such a bad idea.

• Net Gain on Interest Rate Savings: Equity loans and lines of credit cost in range of 5-8% in interest whereas credit cards charge between 9-20% in compounded interest. Depending on the amount of credit card debt one has, this can make a significant annualized difference in savings. For example, if an individual has $7,000.00 of credit card debt at 14%, the nominal non-compounded interest for one year would be $980.00. At 6% through a home equity loan, that amount would be closer to $420.00 nominal i.e. non-compounded.

• Enhanced Individual Cash Flow: With less debt tied up in credit cards, monthly expenses go down all other expenses held constant. This can place one in a better standing with credit card companies and allow for more cash flow with which to manage monthly costs.

Disadvantages

Since homes are often a source of financial security for individuals and family, utilizing the equity in one's home can be a drain on financial assets that may be needed in the future.

• Refinancing causes Re-Amortization of Mortgage: When a mortgage is refinanced to include a second mortgage via a home equity loan, the mortgage amortization schedule can reset meaning the interest payments will likely rise in proportion to capital contributions. The difference between the newly amortized repayment terms and the savings from paying off the credit card debt may be too low to consider.

• Equity leveraging Declines: Should the need arise for a home improvement emergency or unexpected family cost, one may have be required to resort to credit cards once again making the equity loan redundant. In this case, one should assess the potential for future expenses and individual savings and cash-flow to assure the equity loan doesn't use up too much leverage.

Tips on using equity to pay off credit cards

• Negotiate Credit Card Rates First: One may be able to lower the credit card interest rate through credit counseling services or directly with the credit card company. This can save one's home equity and monthly expenses.

• Finance Large Debt: If the debt is large, the potential savings increase than with smaller debt. It may not be worthwhile to take a home equity loan for small amounts of credit card debt.

• Vehicle Collateralize: In some instances, a newer or luxury vehicle can be used as collateral for a loan with more favorable interest rates than credit cards. By considering a vehicle collateralized loan, one can save with a lower interest rate and protect the equity in one's home.

Home equity loans can be a good idea, if the financial circumstances deem them necessary to cut costs and save money. However, it is important to note such loans may not be worth the effort or the cost after mortgage recalculations, unexpected costs requiring future credit card use.

The primary factors one may think about prior to obtaining a home equity loan to pay off credit card debt are the size of the debt, the potential cost savings, future cash flow needs and other lower cost sources of financing the credit card debt pay-off. Should the equity loan still be favorable after such factors are entered into the equation, the loan may be worthwhile.