Anyone who has attacked a pile of credit card debt knows it can be a slow and painful process eliminating those balances one by one. It's easy to be tempted to tap into one's home equity to pay off those cards and then start nipping away at the accumulated debt.
The technique has some advantages. You can sometimes get a lower rate by borrowing against your home equity than you'll get by pestering your credit card companies. Borrowing against your home equity can also be tax-deductible, lowering the cost of the loan even further.
However, when this question came up on the Credit Cards and Consumer Debt discussion board, the board's regular denizens raised a loud alarm.
Here are some of the good points made by these credit-savvy Fools:
- When you use a home loan to pay off your credit card debt, you trade unsecured debt for secured debt. Credit card debt isn't backed up by any of your other assets, just your good name. Home debt, on the other hand, is backed up by your home. Should you default on your home loans, you risk losing your home. Default on your credit card debt, and you'll risk losing your good name, but you probably won't end up homeless.
- "Been there, done that." Some of the Fools on the board still recovering from their credit problems followed the strategy of trading their credit card debt for home equity debt because they thought it was a financially sound move. Unfortunately, they soon found themselves watching their credit card balances grow once again, while also trying to juggle payments on their home equity loans or lines of credit. They recommend ...
- ... Attacking the cause, not just the balances. For many Fools, the pain of paying down all those credit card balances forced them to find the cause of their financial problems and attack it along with the credit card debt. That's a valuable learning experience that may be lost if it looks too easy to wipe out credit card debt with a home equity loan.
- It could take you much longer to pay back your accumulated debt if you move it to a home equity loan than if you attack your credit cards with every dollar you can muster. You could also get a better interest rate by investigating offers to transfer your balance to a lower-rate card.
Knowing the pitfalls of this strategy thus caused many Fools to recommend the old-fashioned debt pay-off strategy: First, assess your debts. Second, rank the order in which you need to start paying them off. Third, attack them with a vengeance.
If you're trying to pay off a serious amount of debt, you'll want to get your interest rates as low as possible. You can get a lot more help in this corner of Fooldom. In brief, you'll want to call your credit card companies and ask them to lower your interest rates. You may also want to consider transferring your balances to lower-rate cards. (Tread carefully, and read the fine print.)
When figuring out what order to use in attacking the outstanding balances, the Fools had a lot of suggestions. For one, you could start with the card charging the highest interest rate, saving yourself money in the long run by getting the most costly debt out of the way first. On the other hand, several Fools said they got a much-needed psychological boost by starting with their smallest debts. Being able to quickly cross something off the debt pay-off list kept them motivated.
Other debts you might want to knock off early include any payments in arrears that you'll need to get current and debts that will quickly lose their special financing rates. Make any credit card that's nearing or exceeding your credit limit a priority. If you owe money to family or friends, figure out where you want them to figure in your debt payoff plan. You may feel better paying them back quickly, or they may be willing to wait if they know you're making serious headway toward getting your finances under control.