Home values are trading sideways right now. They’re even falling in some markets.
But in most cases, the value has still soared vs. just five years ago.
At the same time, Americans are depleting the savings we stored during the early COVID-19 lockdowns. More of us are relying on credit cards at a time when interest rates on those cards are painfully high.
That makes it tempting to take out a loan against the value of your home. But is that something you should do? What if you need to pay off credit card debt and you want to make home improvements?
That’s what a listener of the Clark Howard Podcast recently asked.
Should I Take Out a Home Equity Loan To Pay Off My Credit Card Debt?
Should I take out a home equity loan to pay off my credit card debt and make home improvements?
That’s what a Clark listener asked on the Aug. 28 podcast.
Asked Marie in Florida: “I want to make a couple of improvements to my house and also have $25,000 in debt in credit cards. Should I take out a home equity loan, pay off my cards and improve my house?”
These types of loans are popular this year due to the runup in home values in recent years. But they also expose you to much greater consequences if you don’t make your debt payments.
“The interest rate obviously is going to be far cheaper than what your current credit card interest rate is,” Clark says. “And you can use the money to do the improvements to your home.
“What’s the risk? So you’re taking debt that’s only against your name with the credit cards and you’re making it a debt against your home. If you then can’t pay that home equity loan or line, you lose your home.
“Where right now, credit card debt has a much lower consequence than what we’re talking about if it is rolled into debt against your home.”
Clark on Using Your Home To Pay Off Credit Card Debt: ‘Know Thyself’
If you’re someone capable of running up huge amounts of credit card debt, shifting that debt into your home through a home equity loan or line of credit may only be a temporary solution.
It could be horrible for you financially if you’re not disciplined and careful. I’ll let Clark explain.
“Historically, people who use a home equity line or loan to pay off credit card debt end up with the same credit card balance, on average, I have read 18 months later,” Clark says.
“So you pay off the $25,000 in credit card debt by moving it to a home equity line or loan and then 18 months later you have the $25,000 in credit card debt again plus the $25,000 from prior that is now against your home.
“So you’ve gotta know yourself. Are you going to be able to do this transfer and not run up credit card debt again? If you in your heart of hearts can say ‘I promise myself. I’m not going to run up that credit card debt again,’ then you’ve got at least a caution light from me if not a green light for what you want to do.
“If on the other hand, you can’t make that statement to yourself in your heart of hearts that you won’t run up the credit card debt again, then don’t be tempted by the possibility of transferring that credit card debt to the home equity line or loan you’d use for home improvements.”
Home Equity Loan vs. Home Equity Line of Credit (HELOC)
If you have equity in your home, you can take out a loan or home equity line of credit (HELOC). They use your home as collateral and therefore can usually offer you better interest rates than personal loans, credit cards and other forms of debt.
A home equity loan gives you as the borrower a lump sum up front. Then you make fixed payments and pay a fixed interest rate on the amount you borrowed.
With a HELOC, you can borrow up to a limit that’s determined by a preset limit. Interest rates are variable and payment amounts fluctuate.
“A loan is a fixed rate. The most popular term is five years. So you take out the home equity loan. You know what the interest rate will be. And it stays that way,” Clark says.
“A home equity line is a floating interest rate where the interest rate can change every 30 days. Works more like a credit card against your home instead of a traditional home loan.”
Final Thoughts
Be very careful before pursuing a home equity loan or line of credit to pay off credit card debt. Most people find themselves in the same amount of credit card debt less than two years later.
You’re also putting your home at risk if you’re unable to properly manage the debt. That’s a much bigger consequence than you’ll face if you’re late on a few credit card payments.
You will, however, be able to get a better interest rate from this type of loan than you have on your credit cards.
