You may be hard to reduce your debt if you have big outstanding sums on one or more credit cards. If you can only make minimal monthly payments, it might take years, if not decades, to pay off your credit cards. If you own your house, you might take out a home equity loan and use the money to pay off your credit card debt. But, before you do, you should think about the hazards and some feasible alternatives.
- A home equity loan is one option for repaying credit card debt.
- In general, home equity loans have substantially lower interest rates than most credit cards.
- A home equity loan carries the risk of losing your house if you are unable to repay it.
What Is a Home Equity Loan?
A home equity loan enables you to borrow against the equity in your property that has built up over time. For example, if you own a property worth $300,000 but owing $200,000 on the mortgage, you have $100,000 in equity.
Based on this information, a bank, credit union, or other lender may be prepared to provide a home equity loan equivalent to a percentage of your equity. Other criteria, such as your credit score, can influence how much you may borrow and if you can receive a loan at all.
Advantages of Using a Home Equity Loan to Pay off Debt
The primary benefit of getting a home equity loan to pay off credit card debt is that you will often receive a considerably cheaper interest rate than you are now paying on your credit cards. The average interest rate on a home equity loan is now little under 6%, whereas the typical credit card in Investopedia’s database charges more than 19%.
When you utilize a home equity loan to pay off numerous credit cards, you will simplify your life by having just one payment to deal with each month rather than many.
One previous benefit of home equity loans has been banned, at least for the next few years. Previously, interest paid on a home equity loan was tax deductible, but credit card interest was not. However, as a consequence of the Tax Cuts and Jobs Act of 2017, interest on home equity loans is now only deductible if the loan is used to “purchase, construct, or significantly renovate” the house that secures the loan. This clause is set to stay in place until at least 2026.
Drawbacks to Paying off Credit Card Debt With a Home Equity Loan
The main disadvantage of taking out a home equity loan to pay off debt or for any other reason is that you will be putting your house at risk. Because your house, like your initial mortgage, acts as security for the loan, the lender may take and sell it if you are unable to repay it.
When you are unable to repay credit card debt, you will face major financial implications, particularly for your credit score. However, since credit card debt is not secured by your property, you will be significantly less likely to lose it. Even if you have to declare bankruptcy due to debt, you may usually maintain your primary house.
Other Ways to Pay Off Debt
When it comes to paying off credit card debt, a home equity loan is not your only choice. Here are a couple more ideas:
Transfer your balances to a lower-interest credit card
Some credit cards enable you to transfer balances from other credit cards. This makes sense if you can get a much cheaper interest rate on the new card. Many debt transfer credit cards also offer promotional periods of six to eighteen months with no interest charged on the transferred amount. Transferring a balance from one card to another will not remove debt, but it will help you pay it off quicker.
Take out a debt consolidation loan
A debt consolidation loan from a bank, credit union, or other respectable lender may provide you with the funds you need to pay down your credit card amounts. Debt consolidation loans often have cheaper interest rates than credit cards.
Borrow from your 401(k) plan
Many 401(k) plans enable you to borrow against the funds in your account. If your plan has a loan provision, you might borrow up to $50,000. Furthermore, the interest you pay on the loan is credited back to your account. A few conditions apply to 401(k) loans. For starters, the loan must typically be returned within five years, or sooner if you quit your work. Another disadvantage is that if you are unable to return the loan, it will be classified as a withdrawal, exposing you to income taxes and a 10% penalty on the outstanding sum.
The Bottom Line: Is a Home Equity Loan the Answer to Getting Out of Debt?
If everything goes as planned, a home equity loan might be a terrific option to pay off high-interest credit card debt. However, in the worst-case situation, it may cost you your house.
Consider how strong—or precarious—your existing financial status is while considering if it’s a realistic alternative. If you have a stable employment (or a spouse who does) and are certain that you will be able to make the payments, it may make sense. However, if your employment is in jeopardy and you have no other financial means to fall back on, a home equity loan may be a dangerous decision.
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