Consolidate Credit Card Debt with Home Equity?
I have large credit card debts and good credit. Should I take out a home equity loan to pay off the cards?
We already have a $50,000 home equity loan, and now have hefty credit card bills, about $60,000. We have very good credit, we pay our loan on time and also pay double the minimum amount required by the credit card companies, but we are aware we are paying high interest rates, so we are wondering if it would be wise to get another home equity loan, to pay off the credit cards. Would that affect our credit? I have heard that at times it's not wise to pay off in full the credit cards?
- Routine, on-time payments on a variety of accounts over several years will increase your credit score.
There are a number of considerations you should weigh in deciding a way forward:
- Interest expenses;
- Whether you qualify for a new Home Equity Loan (and whether it is wise to take one out);
- Whether you can stay on top of your credit card balances going forward
- The impact on your credit of the possible approaches
- A different approach to credit card pay down.
Firstly, the question of your interest costs. It is certainly true that the interest rate on a home mortgage or a home equity loan or line is typically lower than the interest rate on a typical credit card. However, the main reason for the lower interest rate is that the loan is secured against your house -- if you default on the new loan, the lender can foreclose on your home. Is the reduced interest cost worth the extra risk that you might at some point in the future face foreclosure.
Qualifying for a new loan
Secondly, you may not qualify for a new loan even were you to want one. You have strong credit, which is great, but lenders typically look at two other things in determining whether you qualify -- so-called DTI and LTV. The Debt-to-Income ratio (DTI) compares your monthly expenditure on your mortgage debt, plus property tax and insurance, and on credit card payments, auto loan payments etc to your total monthly gross income. If that ratio is higher than 45% (often a lot lower than that), you are unlikely to qualify. Given your high credit card balance, this ratio might trip you up.
The Loan-To-Value ratio (LTV) is the ratio of the proposed mortgage balance to the value of your home. If that is above 90-95% you will again struggle to qualify. If your DTI and LTV are low and you can handle the additional risk to your home, either a home equity loan or a so-called cash out refinance might be an option for you. See the Bills.com Mortgage savings center to get no-cost quotes from pre-screened service providers.
Thirdly, have the circumstances that led to high credit card balances in your life now changed? If your expenses continue to be higher than your income you risk running up large balances on your cards again, leaving you in the same position, only now with a larger amount of debt secured against your home. Consider creating and sticking to a monthly budget to ensure you avoid this result.
Impact on Credit Score
Now, as to the question of whether paying off your cards is problematic for your credit score. The short answer is no. Canceling or not using at all cards that you have had for a long time can be detrimental but both using your cards and paying them off every month is the ideal behavior for a high score. You may be interested to read an in-depth response to a question about how credit scores work that I posted recently on my blog: FICO Score Calculation.
Given that you are apparently well able to make double the minimum monthly payments on your cards, you may want to chose a different approach to paying off your cards that will get you out of debt faster:
- Determine the maximum amount you can afford to pay toward your credit card balances.
- Look at your credit card statements and rank your cards in interest rate order.
- Every month, make only the minimum payments on all but the card with the highest interest rate card. Apply all the remaining money you can afford to the highest interest rate card.
- Continue to do this every month until the high rate card is paid off -- keep the total amount you pay every month the same.
- Repeat steps 2-4 with the remaining cards, keeping your monthly payments constant until you're out of debt.
The combination of keeping your monthly payments constant even as your debt balances drop, while applying as much money as you can to the balance on the highest interest rate card every month can take years off the amount of time it takes you to get out of debt. The approach is sometimes called a "debt avalanche" or "the domino strategy."
I hope this information helps you Find. Learn & Save.