Should You Use a Home Loan To Pay Off Credit Card Debt?

Accruing equity is one of the key benefits of owning a home. Like a savings account, this can provide you with a source of funds into which you can tap as you pay down the loan and the value of the home increases. Doing so can be a tempting prospect when you’re trying to eradicate credit card debt. However, you should be aware of a couple of caveats before accessing the equity you have in a residence for this purpose.

In other words, should you use a home loan to pay off debt?

What is Equity?

Let’s say you purchase a home valued at $600,000 with a 20 percent down payment. Rounding the numbers to keep the math simple, means you’ll own a home worth $600,000 against which you’ll owe $480,000.

The amount you owe against the home will decrease as you make mortgage payments. Further, the value of the residence will increase as time goes on and the property appreciates in value — as real estate tends to do. The difference between the fair market value of the home and the amount of money you owe against it is the equity you have in the home.

That money can be accessed in a couple of different ways.

Accessing Your Equity

The simplest way to get the equity you have in a property is to sell it outright. You’ll then pay off the mortgage with the proceeds of the sale and pocket the difference between what you owed and the amount for which the home sold (less the various fees and the like that go along with real estate transactions.)

You can also access your equity in a property by refinancing it to its current value. Revisiting our $600,000 home, let’s say that after five years of ownership, the home is now valued at $660,000. Depending on your interest rate, how your loan was structured, and the number of your monthly payments, you will also have paid down the loan. To make the math easy, let’s say you’ve paid off $12,000 of the outstanding balance. So rather than $480,000, you now owe $468,000. This means you have $192,000 worth of equity in the home (more or less).

You can also borrow against that amount in a few different ways.

Types of Home Equity Loans

The most common method of doing this entails taking out a mortgage for the home’s current value and using the proceeds to pay off the original loan. This will leave you with the difference in cash with which to do as you please. You’ll also start over with a new loan at a higher value amount, which means your monthly payment will likely increase. According to the people at Bank of America Mortgage, you’ll also be subjected to whatever the prevailing interest rate might be when you accept the new loan.

Conversely, you can get a line of credit against the amount of equity you have in the home and use that cash for whatever purpose you desire. This strategy gives you a “draw period” during which you can use the cash up to the agreed-upon amount. Your original mortgage and all its terms remain in place. However, you’ll now also have a second mortgage with terms and a repayment schedule separate from your original mortgage.

Viable Debt Strategy?

Executed carefully, you can come out ahead using home equity. Home loan interest rates tend to be far lower than credit card interest rates. Moreover, the money you were putting toward credit card payments each month could well be enough to service the new debt you’ll take on.

However, you’ll also exchange unsecured debt for secured debt.

You can basically walk away and suffer only collection calls, lawsuits, and a significant reduction of your credit score if you have trouble paying off your credit cards. But you’ll lose your home if you can’t pay off that mortgage-backed loan.

So, should you use a home loan to pay off credit card debt?

The answer really depends upon your ability to service the new debt you’ll incur. You must also avoid taking on the additional debt until you clear the home equity obligation. Otherwise, you’ll be digging an even deeper hole for yourself.