Using Home Equity to Consolidate Credit

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June 2006

Are you carrying balances on high interest rate credit cards? Have you been tempted by all those ads in print, on TV, and on the Internet that urge you to "consolidate your debt—lower your payments in one easy step"? Many of these ads tout home equity loans, second mortgages, or home equity lines of credit as the best or easiest way to consolidate your credit card debt. Could it be right for you? Maybe and maybe not. You need to do a little homework before deciding. My report this month takes a brief look at what you need to consider before using your home equity to consolidate credit card debt.

Should you consolidate debt?

For many consumers, credit card debt is usually the most expensive debt they have. Many of us have fallen into what I call the "plastic habit"—you know, buy now on plastic and pay later. And later. . .and later . . .and later as the interest piles up.

Financial planning experts advise that one of the smartest things that individuals can do is to pay off credit card debt and then use credit cards wisely. Using cards wisely means not running up new balances.

Consolidating debt from several cards or transferring high interest debt on a single credit card to another type loan may make sense if your circumstances fit one or more of these conditions:

• You are carrying a large balance on one high interest card
• You have multiple balances on several cards
• The interest rates on your card or cards are high
• You find yourself making only minimum payments on your cards
• You are having trouble making even minimum payments

What about using a home equity loan to consolidate debt?

As the real estate market has boomed in recent years, many homeowners have enjoyed watching the value of their homes increase, sometimes substantially. A variety of people with something to sell have also noticed. Sellers of everything from home pools to boats to home improvements urge you to tap the value of your home to enjoy a new toy or home upgrade. The Internet, in particular, is full of banner ads and pop-ups, urging you to consolidate debt and "lower your bills" with a home equity loan. But before you make a move that could put your home at risk, it's important to check out the facts and the potential benefits and drawbacks for your situation.

What is "home equity"?

Your "equity" is the estimated value of your home minus any amount you owe on the mortgage(s). For example, let's say that your home is currently valued at $325,000 and you have $175,000 principal left to pay on the mortgage. Your home equity is $150,000.

What types of Home Equity Loans exist?

Home equity loans generally are available in three types: fixed-rate installment, lines of credit, and combinations of the two.

• Home equity fixed-rate installment loans provide a specific sum of money at a fixed rate of interest for a specific amount of time. The monthly payment and interest remain the same for the life of the loan.
• Home equity lines of credit, sometimes called HELOCs, are a form of revolving credit in which your home serves as collateral or security. These loans provide a credit limit (maximum amount of credit) that you can borrow against. A HELOC allows you to borrow money when you need it. HELOCs have a variable interest rate that fluctuates over the life of the loan and is based on a published index. Payments may vary depending on the interest rate, the amount owed, and other requirements of the specific HELOC. For example, some HELOCs (but not CCU's) have a fixed period (called a draw period) during which you can borrow money and a repayment period over which to repay the loan. During the draw period in these type loans, your monthly payment may only cover the interest.
• Home equity combination loans combine features of HELOCs and fixed-rate installment loans. The basic loan is a HELOC. The combination feature allows you to draw an amount and fix the interest rate. As you pay off the principal in the fixed-rate portion, it becomes available for borrowing in the line of credit.

CCU offers fixed rate and line of credit home equity loans. You can read more about their specific features on the Home Equity Loans page.

What are the potential benefits of using a home equity loan?

Generally speaking, home equity loans offer three big advantages:

• The interest rate is typically lower than credit cards or unsecured personal or signature loans.
• The interest may be tax deductible on your income tax returns. You will need to consult your tax advisor.
• The closing cost is typically paid by the financial institution. You will need to check with your financial institution for details.

What are the potential drawbacks of using a home equity loan?

• If you can't pay back your loan, you can lose your home. The collateral that secures the loan is your home. If you are considering taking out a home equity loan because you are so financially stretched that you are having trouble meeting your monthly bills, stop and seek some credit counseling first. CCU offers members a credit counseling program.
• If home values drop, you could end up owing more than the house is worth.
• HELOCs have variable interest rates so monthly payments can rise.
• Using a home equity loan to pay off debt may make monthly payments lower but because you are taking more time to pay off the debt, the total amount you have to pay could be larger.
• With a HELOC, accessing the funds may be so easy that you are tempted to use it for more than consolidating credit card debt.
• A HELOC may include a balloon payment. In these types of HELOCs, during most of the loan terms you may be paying only interest and then at the end of the loan term, the entire balance is due. This could be a large sum depending on how you've used the line of credit.

Are there other options for consolidating credit card debt?

Yes. In considering a home equity loan, you should compare it to other options. For example, you might consider using a personal (signature) loan from CCU. It can be used to pay off your credit card debt for a lower monthly payment. Compare the terms and your circumstances, then decide.

If you need help in better managing debt, CCU provides members a credit counseling program.

Because as a member, you're an owner of your credit union, CCU's first goal is provide choices and help you make financial decisions that work to your advantage. Take a look at your total credit card debt and the terms then compare your options at CCU including our home equity loan options.

StraightTalk Tip: Remember your purpose in consolidating credit card debt is to get rid of it. Resist the temptation to run up new big balances on your cards. Experts recommend using your best interest card wisely, paying off the balance promptly, and putting the remainder of the cards away (or cutting them up).

Prepared for Corning Credit Union by Remar Sutton & Associates, June 2006. Reviewed March 2007. All rights reserved.