Credit card interest rates are high. They may not be as oppressive as payday loans, but they are still excessive as they sometimes begin at rates exceeding 20%.
As some consumers calculate the rising level of credit card debt they have, they may consider their options in eradicating the debt to include consolidations, which should only be used as an absolute last resort before the option of bankruptcy. But other than these options, there is always the choice of taking money out on one’s home equity, commonly called a HELOC for Home Equity Line of Credit.
What is a HELOC?
When a person owns a home with a mortgage there are two kinds of money. The first is the money owed on the loan, called the principal, and the second is the difference between what the house is worth, and what is owed on it, called equity.
If a family had $20,000 in credit card debt while owning a $200,000 home of which $100,000 was owed on the mortgage, it would not be hard for this family to take out a loan for the credit card debt amount (or more) using the equity as collateral. This line of credit is a HELOC. While it is a simple procedure to execute, it is not without its pros and cons.
Taking out a HELOC to pay off Credit Card Debt: Pros
The best reason to take out a HELOC to pay off the above credit cards is to be rid of the high interest debt. Where the family was once beholden to a creditor for $20,000 at 23.9%, they may have transferred the debt amount to a lender who only wants 8.9% interest.
Another positive is that the limits will increase on the cards that were paid off. This is not a guarantee, but it has been my personal experience that when I have had a high balance on my credit card and then paid it off, my limit went up. This higher limit brings one’s debt to credit ratio down, making him or her a more desirable candidate for loans in the future, which can also be a con.
Cons to Reducing Obligations via a Home Equity Line of Credit
The biggest con to this transaction is that it encourages people to utilize their home as a means of paying for consumer items. The credit card debt would be a result of a variety of spending to include air fare, dining in fine restaurants, going to Starbucks for a cup of coffee, and even paying for one’s cell phone bill.
While it is one’s right to use their home’s equity, or any other part of their net worth, in the ways that please them, there may come a time when spending habits will exceed one’s ability to keep up with them. After all, much of a mortgage payment goes to interest, making the equity one gains comparable to a tortoise (paying down the mortgage) racing a hare (credit card spending) that may not stop to sleep on its way to the finish line.
Another con is having the same amount of debt, but just by another name, freeing up the credit cards to be used even more freely than before. Psychologically, this could lead to even more credit card spending, especially when one gets cash back rewards.
Overall, HELOCs are not the best way to go, but they should be considered before getting involved in a debt consolidation, and would be much more preferable to filing for bankruptcy.