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Debt consolidation with home equity
Thousands of Americans have problems with credit card debt. It’s big, it’s bulky, and it’s expensive. It’s also hard to lose. For many people, once you get it, you can’t get rid of it. One option is to trade that debt for a home equity loan. Is that a good idea?
Read on.
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Debt consolidation may help or hurt, depending on you
The typical American family carries a boatload of debt, and a lot of it comes from credit cards. They’re convenient and easy to carry, but they can also get you into big financial trouble if you’re not careful. And many people aren’t, as studies show that the average household owes nearly five figures on their credit cards. At typical interest rates charged by these lenders, it’s easy to end up with debts that can take years, or even decades to pay off. And if you pay late, the “default” interest rate kicks in and it gets even worse. Paying off $20,000 in credit card debt at 30% annual interest is painful, indeed.
Debt consolidation is one solution. You can take one or more high-interest credit card loans and transfer them to another loan at a lower interest rate. Once solution that may people might find useful these days is to leverage their home equity to borrow money to pay off the credit card debt. This can be done in one of three ways:
- Cash out refinance - You simply get a new mortgage for the sum of the amount that you owe on your house and the amount of your debt. Your interest rate drops, the interest is tax deductible, and you have 30 years to pay it off.
- Home equity loan - You take out a second mortgage and use that money to pay off your credit card debt. Again, the interest is deductible, but you still have two bills to pay each month - your first mortgage and your home equity loan.
- Home equity line of credit - Similar to a home equity loan, but this is a renewable loan that can be used again and again as you pay it off.
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Are these good ideas? Maybe, depending on how much discipline you have. Here are some things to consider:
- Your credit card debt is considered unsecured debt; you have not presented any collateral to the lender in exchange for the loan. They can sue you if you default, but that’s about it. Your home, on the other hand, is a secured loan, secured by your house. If you default on that, you put your house at risk and you could lose your home to foreclosure.
- If you do a complete refinance, you are now agreeing to take a full 30 years to pay off your credit card debt. Did you really want to do that? Over the next 30 years, you will still pay thousands in extra interest.
- If you consolidate your debt into a home loan of any sort, you have now paid off your credit card accounts. It won’t do you any good to do that if you just return to your old spending habits. If you just go back to reckless spending, you have potentially made your situation twice as bad, and you can easily run up twice as much debt as before.
If you have the discipline to stop spending on your cards, consolidation through a home loan can make sense. But it’s all up to you. If you can exercise restraint, it’s a good idea. If not, you should probably avoid it.
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