Dealing with credit card debt can be seriously stressful. If you’re struggling to get your balance under control, you may have considered consolidating your cards onto one low-interest loan.
One consolidation option available to homeowners is a home equity line of credit. But what is a HELOC, and is it smart to use one to deal with your credit card debt? Take a look at the details below to decide if this option is right for you.
What is a HELOC?
Before discussing the benefits and drawbacks of using a HELOC to consolidate your credit card debt, it’s important to understand the ins and outs of this financial product.
A home equity line of credit, or HELOC, is a line of credit you take out from a lender. The amount of your credit line depends on how much equity you’ve built up in your home. Usually, banks will lend customers with good credit up to 85% of your house’s assessed value, less the amount you still owe on your mortgage.
Like a credit card, a HELOC is revolving debt. This means you can borrow against it, pay it off, then borrow again – just like you would with a credit card. You don’t borrow from it and repay it in installments until it’s paid off, as you would with a home equity loan.
However, unlike a credit card, a HELOC is a secured loan. This is because you’re borrowing against the equity in your home to obtain the line of credit.
Advantages to using a HELOC to consolidate your cards
HELOCs are often touted as a great vehicle for consolidating high-interest debt. This is because they have some advantages, including:
Lower interest – Because HELOCs are secured by your home, their interest rates are significantly lower than credit cards. Additionally, rates on home loan products (including HELOCs) have been at historic lows since the Great Recession. This means that if you roll several cards onto one HELOC, you could save serious money on interest payments.
Tax deductible – HELOCs are sometimes referred to as “second mortgages” because they require you to borrow against the equity in your home. Like first mortgages, the interest you pay on them is usually tax-deductible. Again, this could add up to savings when tax time rolls around.
Risks to consider
For some homeowners, consolidating credit card debt with a low-interest HELOC makes sense. But it’s important to be very careful. HELOCs have some serious drawbacks. For example:
Expensive – To obtain a HELOC, most lenders charge fees similar to those you paid when you took out your first mortgage. This means you’ll have to do some math to figure out if the up-front costs will be outweighed by the interest savings you’ll see in the long run.
Unstable – Most HELOCs are variable-rate, meaning that your monthly payments could change with economic conditions. If you’re on a tight budget, this could be a problem.
Your house is on the line – The most serious risk to using a HELOC to pay off your credit card debt is that, in doing so, you’re putting your house on the line. If you don’t pay on your HELOC, you could get foreclosed on. Since most people have a lot of their wealth (not to mention security) tied up in their homes, this is a very big deal.
High “drowning” risk –If your home drops in value while you still owe money on a first or second mortgage, you could end up “underwater.” This means that you owe more on your home than it’s worth. This is a precarious position to be in because if you need to sell your home, you’ll have to bring cash to the table to do so.
The takeaway: Using a HELOC to consolidate your credit card debt can be a smart move if you borrow carefully and repay the loan quickly. Just be sure you can handle the risks involved. Borrowing against your home’s value shouldn’t be taken lightly.