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Is it a good idea to Pay-off credit card debt with a Home Equity Loan?

Is it a good idea to Pay-off credit card debt with a Home Equity Loan?

As a bankruptcy attorney I am often asked if it is a good idea to pay-off credit card debt with a Home Equity line of credit? Typically, the answer is NO. Consider the following:

If you pay-off your credit card with a Home loan, you will have more room on your credit cards to incur more debt.

This is a very common trap. If you have developed a habit of using credit cards, that habit is not going to change just because you consolidated your credit card debt into Home Equity loan which is essentially a second mortgage on your house. In fact, the reverse happens to be more likely. Essentially, you have developed a habit of using credit cards or habit of incurring debt with every swipe, and, now, you are attempting to resolve the problem of incurring debt by incurring more debt (getting another loan called a Home Equity Loan). Judging from experience, people are way more likely to incur more debt once they have paid off their credit card debt with a home equity loan. They simply keep on using their credit cards and, before they know it, they end up having a home equity loan AND even more credit card debt. If the habit of incurring debt is there, it is not going to go away on its own. One must replace that habit with a different and more healthy habit; otherwise, history will repeat itself.

Instead of getting another loan to pay off other loans, work on paying off the debt you already have without incurring other debt. Think about it, by paying off debt, you will be substituting the habit of incurring debt with the habit of paying off debt.

Home equity loan with a lower interest rate is a trap!

I am often reminded by my clients that the interest rate for a Home Equity loan is typically lower than the interest rate their credit card companies charge. This is simply not a good reason to incur debt to pay off debt. Two wrongs don’t make things right. The difference in interest rates is not worth the risk. Focus on paying off debt and worry less about interest rates.

There is a reason why a Home Equity loan may have a lower interest rate than a regular unsecured credit card. If you default on an unsecured credit card payments, the credit card company’s remedy is to sue you, but a mortgage company can foreclose on your property if you default on the Home Equity loan.

Because creditors have more ways of collecting on the money they loaned, they have less risk in collecting the money. Since they have less risk in collecting the money they have loaned, they typically charge lower interest rates.

In other words, by transferring debt that is not attached to your house (credit card debt) to a debt that is attached to your house (Home Equity Loan or a Mortgage), you are significantly increasing the risk of losing your home, for a potentially lowered interest. It is not worth it!

Also, general unsecured debt can be discharged in bankruptcy, but a second mortgage typically cannot be discharged (if you are keeping your home). This should be a major consideration if you are considering filing for Bankruptcy.