Should You Borrow Against Your Home To Pay Off Your Credit Cards? (No).
Do you have pretty serious high-interest credit card debt?
Perhaps you owe Visa or MasterCard a frightening five-figure sum ... and that balance is exploding, due to uncontrollable double-digit interest.
You want to get out of credit card debt and you feel like you’re already living as frugally as possible and saving as much as you can, but you’re still not making any headway. You can’t see the light at the end of the tunnel.
You do have one good thing going for you, however: you’ve got plenty of equity in your home.
Maybe you made a nice 20% down payment when you first bought your home. Maybe you’ve owned your home for a number of years and it’s risen in value during that time, giving you a solid chunk of equity. Or maybe you inherited the home. Regardless of the reason, the simple fact is that you are the owner of a house that has a significant amount of equity.
You're aware that you can take out a home equity line of credit or facilitate a cash-out refinance. Both of these options would give you the capacity to have a nice lump sum of cash, which you would then use to repay your credit cards.
You're also aware that the interest rates on these loans would be significantly lower than your credit card interest rate. You might only pay 5% or 6% when you borrow against your home, as compared with the 14% to 22% or higher that you might be paying on a credit card.
When you present the argument in that type of a framework, borrowing against your house in order to pay off your credit cards sounds like a no-brainer. You might be wondering why anyone wouldn’t do it.
But in reality -- (and I’m going to be blunt) -- this is a terrible plan. Here are the reasons why you should NOT borrow against your home in order to repay your credit cards:
1. Secured versus unsecured debt.
Credit card debt is unsecured, meaning that if you default on the loan, the lender cannot repossess anything.
Think about it for a second. You might have used your credit card to purchase clothing, restaurant meals, gasoline for your car, groceries, haircuts and other day-to-day purchases. There’s absolutely no way for a lender to take that back.
Your home, on the other hand, is a secured loan. That’s the reason that the interest on this loan is lower. If you default on a home loan, the lender can foreclose on you -- and that is not a situation you want to be in, particularly if you love your home or if you’ve owned it for a long time.
All things considered, it’s far safer to carry unsecured debt.
2. Old habits die hard.
The vast majority of people who borrow against their home in order to pay off their credit card loans end up quickly finding themselves back in credit card debt. In other words, borrowing against their house doesn’t make their problems go away. It only makes their problems worse. Now they still have credit card debt and an additional home equity loan.
I’m going to rephrase this one more time just to drive home the point: Borrowing against your house in order to repay your credit card debt is a recipe for ultimately drowning in more debt rather than less.
I know you think that this isn’t going to happen to you. You assume that even though this happens to the vast majority of people, you are special. You will be the one exception to the rule. If you would allow me to be blunt, however, let me reassure you that's what everybody else thinks as well.
Life can be hard. In a few years from now, you might find yourself in a special circumstance. Perhaps you and your spouse both lose your jobs at the same time. Perhaps you get hit with huge medical bills, or you have to take care of a sick family member, or your car and all of your appliances break on the same day that your roof starts leaking.
When these types of disasters happen, even the most well-intentioned people often end up resorting to credit cards in order to bail themselves out. If this happens to you, you’ll discover that now you’ve compounded your debts ...
and you certainly can’t default on any of these loans, because you’ll run the risk of losing your house if you do.
3. Learning Tools.
There’s a very good reason why financial expert Dave Ramsey recommends that everyone save a $1000 emergency fund prior to paying off their debt.
It’s not because this step makes the most mathematical sense. It's because this step makes behavioral sense.
By saving a $1000 emergency fund before you begin making extra payments on your debt, you will form the behavior (habit) of relying on your savings rather than your loans to bail you out of situations. And once you’ve repaid your credit card debt, your crucial next step is to save an emergency fund that covers anywhere between three to nine months of your personal expenses.
Again, this is for a very good reason. It’s so that you can form the behavior pattern of relying on savings instead of relying on debt. If you use your home equity line of credit in order to bail yourself out of credit card debt, you’re not setting yourself up on a good behavior pattern.
It’s time to learn strong financial management skills, and this starts with relying on your savings in order to bail you out of situations, rather than simply transferring balances from one type of loan to another.
So what should you do? Forget the fact that you have any home equity to tap whatsoever. Focus on building a small emergency fund (start with $500 or $1,000) while simultaneously paying off your debt. This is going to require that classic one-two-punch of saving as much money as possible and also working a second job during the evenings and weekends so that you can ramp up your earnings.
Keep diligently chipping away at your credit card debt. Once those cards are paid off, you’ll be happy that you can sleep soundly at night without worrying that your home will be taken away from you.