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Home Equity Temptation

Credit Wise (featured column)
by Jennifer Wallis

With interest rates so low, an increasing number of consumers are acquiring home equity loans to pay off their credit cards. While taking out a tax deductible, low interest loan to repay non-tax deductible, high interest credit card debt may seem like a no-brainer, there can be a dark side to this decision.

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If you’re considering taking out a home loan in order to pay off other debts, it’s essential to have all of the facts so that you can make the best decision for you and your family. Here are some things that every homeowner should know before you possibly put your home at risk.

The Upside

Interest rates:

Typically, interest rates on home equity loans are much lower than the standard rate credit card companies charge. This can certainly save a lot of money over the life of the loan. Interest paid on home loans is also tax deductible, where credit card interest is not.

One monthly payment: 

Sometimes juggling several credit card due dates can get confusing. If you consolidate your bills with a loan, you only have to worry about one due date and one payment.

Fixed number of payments: 

Unless you choose to use the line of credit option when using a home equity loan, you will have a set payment schedule with a fixed number of payments. You will know an actual date that the loan will be paid off. With credit cards, it can take many years to pay them off if you’re just paying the minimum.

The Downside

The risk:

When you take out a home equity loan, you pledge your home as security for that loan. Although we may all assume debts with the best intentions to repay them, unforeseen tragedies happen every day. If circumstances change where you are unable to repay your home equity loan, you could lose your home.

The temptation:

If you are borrowing money to relieve the burden of credit card debt, you may end up with a lot of credit cards with no balances. It can be so tempting to just use them a little here and a little there until before you know it, you end up with a home equity loan AND credit card debt. If you’re serious enough about being debt-free to take the step to borrow against your home, do it the right way. Close the accounts and make confetti out of the credit cards.

The fine print: 

Be sure to be aware of the fees associated with the loan. You’ll usually have to pay closing costs and an appraisal fee, among others. Make sure that the interest savings will be great enough to counter these up-front fees.

Longer payout: 

If you’re serious about getting out of debt, developing a Rapid Debt Repayment Plan can usually help you repay your credit cards in a relatively short period of time. Some home equity loans can take as long as 15 years to repay. It’s a good idea to compare the dollar amount of interest you will pay with the home equity loan to the amount you would pay on a Rapid Debt Repayment Plan. Even at a much lower interest rate, a home equity loan with 10 more years of interest may be a much more expensive option.

To develop your own Rapid Debt Repayment Plan

Calculate your current minimum credit card payments and pledge to always send that amount to your creditors, this “rollover” method (not reducing your payments as the   minimum required payments decrease and rolling over money as creditors pay off) can quickly reduce debt. For example, your  total minimum credit card payments are $300.00 per month for $15,000 of debt. If you sink $300.00 toward your credit cards each month, you will be debt-free in about 5 years.

The bottom line when making any major financial decision is to weigh your options and choose the one with which you’re most comfortable. If you decide that a home equity loan is the best solution to become debt-free, make sure that you know exactly what you’re getting yourself into. Make the commitment to repay the loan, never use the credit cards again, and you may just be rewarded with a great sense of accomplishment.

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Copyright © 2003 by Jennifer Wallis. All rights reserved.

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