Should you pay off credit cards with a home equity loan?
One of Shakespeare’s oft-quoted lines — “Neither a borrower nor a lender be” — is sage advice, especially for many cash-strapped Americans. But perhaps you haven’t followed Shakespeare’s wise counsel. If credit card payments are taking a big chunk from your paycheck, you may wonder if it’s a good idea to use your home equity to consolidate high-interest credit cards into a more affordable monthly payment.
First, a little background. Home equity is the difference between what your home is worth and what you still owe. If your home could sell for $200,000 and your mortgage balance is $100,000, you have $100,000 in equity. Banks and other financial institutions will often grant loans or lines of credit based on that equity. A home equity loan is essentially a second mortgage. By pooling credit card balances into a single home equity loan, you’re not getting rid of debt — you’re trading one type of debt for another.
Is this kind of debt consolidation a good idea? It can be. For one thing, a lower monthly payment can free up cash. Also, trading variable rate credit cards for a lower fixed rate loan can help with financial planning and bookkeeping, and may save you interest in the long run. In addition, interest on a home equity loan or line of credit may be tax-deductible.
With your credit cards paid off, lots of available credit could soon be staring you in the face. As Hamlet put it, “There’s the rub.” If you fail to modify the spending habits that dragged you into debt in the first place, you may end up making payments on a home equity loan and credit cards.
Another thing to remember with this kind of debt consolidation scenario: your home is on the line. Why? Credit card debt is generally unsecured. That means it’s not collateralized by anything but your good name. If you don’t make credit card payments, you may be hounded by bill collectors, but they won’t foreclose on your home. Not so with home equity loans. They’re secured by your house. If you default, you may find yourself looking for new digs.
Shakespeare also said, “To thine own self be true.” In other words, don’t kid yourself. If you’re prone to impulse buying and likely to dive into debt again, think twice about taking out a home equity loan to pay off credit card balances.
Check out the pros and cons of debit cards
Open your wallet and compare your debit and credit cards. Both probably sport a logo, an embossed account number, an expiration date and, of course, your name. Both may even come with the same nifty picture and background color. In fact, the only distinguishing characteristic may be that little word “debit” on the face of, you guessed it, your debit card.
But they’re not the same, and knowing the differences between these two cards — as well as the pros and cons of each — can keep your bank accounts intact, your credit rating strong, and your purchases hassle-free.
In general terms, a debit card is like a blank check. When you swipe a debit card through an electronic card reader, you’re filling in the payee line. The merchant verifies that you have enough money in your bank account to cover the purchase. If you do, the transaction is approved and the money is deducted — right then and there — from your account. A credit card, on the other hand, is a promise to pay. The store only checks to see that your credit line hasn’t been exceeded. The transaction is added to your account and at the end of the month you only have to cover a minimum payment.
Debit cards can be a great tool. Like credit cards, they’re convenient. Your wallet doesn’t bulge with paper currency and swiping a card is faster than writing a check. You can even save a trip to the ATM machine by using the card’s cash-back feature. With a debit card you’re only spending money that’s actually in your checking or savings account, so you’re forced to budget. No money, no purchase. Another big advantage: no interest or late fees.
On the other hand, debit cards have some distinct disadvantages. If you don’t use a credit card, even stellar spending habits won’t bolster your credit score. And debit cards may not offer the same level of protection as credit cards. If your debit card is lost or stolen, your maximum liability may be greater. (Check with your financial institution to learn their particular policies.) Another thing, with a credit card you can withhold payment if you’re dissatisfied with a purchase. Purchase with a debit card and the store already has your money. You have less leverage. Are both types of card in your wallet? Use them, but watch out for hazards.
