Is It Wise to Use a Home Equity Line of Credit to Pay Off Debt?
A home equity line of credit, also known as a HELOC, is a loan taken out with the homeowner's primary residence held as collateral for the line of credit. The homeowner can then write checks from the HELOC for any purpose, including paying off other debts such as credit cards, car loans and student loans.
Other People Are Reading
-
Expert Insight
-
Gerri Wills of CNN Money advises that using a HELOC to pay off debt "can be a smart move," and Smart Money agrees it "might be a good escape hatch." However, both experts caution that although a HELOC can be wise from the perspective of saving money on interest, it can hurt homeowners who do not manage money well. They also caution homeowners to be sure they are not borrowing the full value of their home because if the housing market drops, the mortgage plus the HELOC may be more than the house is worth.
Advantages
-
One of the main advantages of taking out a home equity line of credit to pay off other debts is that the consumer is likely to pay a much lower interest rate on the HELOC than on the other debts. Another advantage is that all of the interest paid on the HELOC is tax-deductible for homeowners who itemize their deductions. This is not true of interest on other types of debt such as car loans and credit cards.
-
Time Frame
-
A home equity line of credit typically has a 10-year draw period in which the homeowner can borrow money from the line of credit and make interest payments only on the amount borrowed. At the end of the draw period, some HELOCs require a balloon payment, which is a payment of the full principal amount borrowed, where others transition into making interest and principal payments. The home equity line of credit allows the homeowner to delay paying principal, which can be helpful during a time of low income, such as a loss of a job, having a new baby or going back to school.
Considerations
-
Homeowners should be careful to not use a HELOC as a license to overspend. After taking out a HELOC and paying off credit cards, some people may go back to those credit cards and make more purchases they cannot afford, leaving them in the same situation as before, but now with payments to make on the home equity line of credit in addition to the credit cards. Because the HELOC allows homeowners to borrow up to the maximum approved amount on the credit line, that additional money in the home equity line of credit can also be used to overspend, so borrowers should consider its use carefully.
Warning
-
Because the homeowner's house secures the HELOC, getting behind on payments can result in losing the home. In addition, because HELOCs have adjustable interest rates, monthly payments increase when the prime rate goes up. Homeowners should carefully consider whether they can make the payments, even if the interest rate goes up, and whether they are willing to bet their home on it.
-
