Should You Use a Home Equity Loan or Line of Credit to Pay Off Credit Card Debt?
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If you are in credit card debt, you are not alone. The average amount of credit card debt is over $5,600, according to TransUnion. This is the highest it has been since 2009.
Furthermore, if you are only making the minimum payments on your credit cards, it could take you up to 30 years to pay off your credit card debt. That’s assuming you don’t make any more additional charges ever again during those 30 years.
So, if you are going to get out of credit card debt in less than 30 years, you need a plan of attack and a way to reduce your interest costs. A home equity loan or home equity line of credit is a great way to pay down credit card debt and you can consolidate your debt when doing so, as well.
Using a Home Equity Loan to Pay Off Credit Card Debt
One way to reduce or eliminate your credit card debt is with a home equity loan. You’ll get a lump sum at closing that you can use to pay off your credit cards. Home equity loans are secured by your home, so the interest rate on the loan is much lower than unsecured credit card interest rates.
Plus, you’ll have about 10 to 15 years to pay off the loan balance. The downside is that you’ll have to repay the loan sooner if you sell your home because you won’t own the collateral property anymore. In addition, you risk losing your residence if you default on your home equity loan.
Using a Home Equity Line of Credit to Pay Off Credit Card Debt
A home equity line of credit (HELOC) is similar to a home equity loan and, like most financial products, has its pros and cons. Your maximum credit line on a HELOC is also determined by the amount of equity you have in your home. The interest rate on a HELOC is usually variable, but it is still much lower than credit card interest rates.
Since the HELOC is secured by your home, the interest rate is usually just a little higher than current mortgage interest rates. A HELOC credit gives you a maximum amount that you can borrow and you choose how much of the credit you want to use at any particular time.
Unlike the home equity loan, you can continue to access the line of credit to pay down additional debts as you repay the home equity outstanding balance. The risks associated with the HELOC are the same as those of the home equity loan. Borrowers risk losing their home if they default on the line of credit. In addition, you’ll have to repay the line of credit if you sell the property.
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Alternatives to Consider
There are additional financial tools to lower your interest expenses and pay down your outstanding credit card debt. One tool involves using credit cards to pay off your credit cards. It may sound counterintuitive, but you can use the 0% interest incentives that new credit cards can offer.
There are fees associated with transferring your balance from a high-interest credit card to a new one with a 0% interest rate, but the interest savings usually outweighs the cost of the transfer. These low interest rates are only good for a short period of time, so you’ll want to make sure that you know when regular interest charges start so that you can move your balance to a new 0% interest credit card by that time.
Personal loans are another way to pay down your credit card debt. A personal loan is an unsecured loan, so the interest rates are higher than they are on a home equity loan. Interest rates, however, tend to be at least half of average credit card interest rates.
Unfortunately, you may not be able to borrow as much with a personal loan as you could with a home equity loan. In addition, the repayment terms are usually from only three to seven years.
How Your Credit is Affected
If you make timely payments on your home equity loan or HELOC, you should see your credit score increase. Credit scores are higher for borrowers who successfully repay their debts and make timely payments. Credit scoring formulas also seem to favor secured debts such as mortgages, home equity loans, and car loans over unsecured debts such as credit cards.
Even though you may not reduce your overall debt burden by using home equity loans to pay off credit card debt, credit-scoring formulas will probably view the shift from riskier credit card debt to less risky home equity debt favorably. As you continue to pay down your debt, you should see small improvements to your credit score over time.