- While you can borrow money using your home as collateral, it is not an effective way to pay off unsecured debts like credit cards.
- Failing to make payments on a loan secured by your home could result in the loss of your home through foreclosure.
Your home is likely your largest asset. In many cases, its value surpasses savings and retirement investments. Because your house can play a vital role in a secure retirement, you should tap into its equity with the utmost caution.
It may seem like a good plan to transfer high-interest credit card debt to a low-interest home equity loan. However, there are numerous reasons why this is a terrible financial decision that could have devastating consequences for your financial wellbeing.
What is Home Equity?
Home equity is the value of the house minus any liens. For example, if your home has a market value of $400,000 and your current mortgage is $250,000, then you have $150,000 in equity. Home equity grows through appreciation and paying down mortgage debt.
Secured Debt Versus Unsecured Debt
All debt is either secured or unsecured.
Secured debt guarantees the loan with some form of collateral. Your home, vehicle, stocks, or other assets can secure a loan. When you guarantee a loan, lenders typically offer more favorable terms. The problem is that if you are unable to make payments, the lender will take the asset to repay the debt.
Your goodwill backs unsecured debt, giving lenders limited means to collect unpaid balances. This means you won’t lose your home if you default on credit card debt, but you will if you cannot make payments on a home loan.
It is always a bad idea to transfer unsecured debt to secured debt because you give lenders more recourse to collect the debt.
The Cost of Accessing Equity
There are three ways to access your home equity. You can refinance and get cash out, get a second mortgage, or open an equity line of credit. The costs vary depending on the route you choose, but all have high closing costs.
Lenders must establish a value for the property and scrutinize your finances to determine your ability to repay the loan. The process can take 60 days or more and cost thousands of dollars in closing costs.
Extends the Time it Takes to Get Out of Debt
Most home loans have a 30-year repayment schedule. Transferring credit card debt into a home loan will extend the debt payoff for the length of the loan.
Using other methods to pay off debt, such as debt settlement, can eliminate unsecured debts in four years or less, leaving you paying less and finding financial freedom sooner than a home equity loan offers.
Future Financial needs
It takes time to establish equity in your home. Using it to pay off credit card debt could leave you without access to that equity for future needs. Paying down your home could allow you to retire without a mortgage or downsize your home for a mortgage-free retirement.
Changing Your Spending Habits
Perhaps the biggest reason not to seek a quick fix to your financial problems is that you do not have time to change spending habits. When you roll over debt into a home loan, you now have open credit lines tempting you to charge new debt. Without changing spending patterns, you could find yourself deeper in debt with no available equity to bail you out the second time around.
Should I use my home equity to pay off my credit cards?
While a home equity loan offers a lower interest rate, using home equity to pay off credit card debt converts unsecured debt to secured debt. Meaning, if you fail to pay a credit card, the lender has limited means to collect. Failing to pay an equity loan could result in losing your home.
Can I use a home equity loan to consolidate my debt?
One of the benefits of homeownership is access to the equity in your home as prices rise and you pay down the mortgage. Once you have sufficient equity in your home, banks will allow you to convert that equity into cash through a home equity loan. You can use the loan proceeds for anything you wish, including paying high-interest debt.
Why using home equity to pay off unsecured debt is a bad idea?
For most families, your house is your biggest investment. Building equity in your home could allow you to retire without a mortgage, pay cash for a smaller home, or use the equity as a nest egg in retirement. When you liquidate equity for anything other than home improvements could undermine your future financial security.