Should you use a HELOC to pay off credit card debt? Pros, cons and risks

Dear Chuck,

I maxed out our credit card for some unexpected home repairs, including a new HVAC. The interest rate is ridiculously high since I did not pay it off last month. I’m considering using a HELOC to pay off the credit card. Is that a good idea?

Worried About My Credit Card Balance

Dear Worried About My Credit Card Balance,

My first reaction whenever someone tells me that they are planning to use debt to pay off debt is to say, “You are tap-dancing on hot coals.” Moving short-term debt to long-term debt to lower the interest rate or the monthly payments may be necessary for the relief you seek, but at some point, you can get really burned.

It would be helpful to have a full conversation to understand your overall picture. I don’t want to presume anything about your circumstances, but the next questions I would ask are:

• Do you have a budget in place? If not, start there. Here are some helpful resources.
• Are you tracking your spending and cutting back where you can? This is the best way to start digging yourself out of a hole.
• Can you make a different plan to pay off this credit card debt? I hope so!
• Can you generate extra income that could go directly to paying off the credit card?

A better way

If credit card payments are becoming difficult or you want to lower the interest you’re paying each month, here are several steps and options that may help:

• First, contact the credit card company and speak with someone to negotiate the terms. If you have good credit, you may get annual or late fees waived and a reduced interest rate. Get the new terms in writing, and if possible, set up automatic payments to avoid missing one.
• Consider a 0% APR balance transfer card. Make sure you understand all terms, including the fee and the length of the 0% rate. You must exercise self-control to pay it off on time to avoid high interest rates. Avoid adding any credit card debt during this time.
• Set up a debt reduction plan that meets your current needs.
• Generate extra income dedicated to paying off the credit card. This is the fastest, best option.
• Consider a personal line of credit to consolidate debt at a lower interest rate.
• Research a home equity loan.
• If mortgage rates drop, cash-out refinancing is an option.

HELOCs — the good and the bad

Only consider a home equity line of credit (HELOC) if you have a significant amount of home equity, are disciplined in your spending, and have a secure source of income. Be sure you can check all the boxes I just listed.

While helpful in lowering borrowing costs, they come with risks. They have variable rates and are secured by your home. Missed payments can endanger home ownership. This kind of loan requires time, paperwork, possibly an appraisal, an origination fee, and closing costs from 2–5% of the loan amount. Other fees may be charged for a credit report, a notary, and a title search. These can easily cost several thousand dollars, depending on the desired line of credit. If you decide to apply for one, make sure you have a repayment plan in place.

The amount you can borrow is determined by your credit score, debt, income, mortgage payment history, and home equity. If you sell your home before paying off the HELOC, proceeds from the sale will be used to close out the debt. Only go with a legitimate lender. Research customer reviews, ratings, and any regulatory action or lawsuits against the company. Applications received online or in the mail that you did not request are most likely scams.

If you itemize deductions on your tax return, any interest from a HELOC that is used to buy, build, or substantially improve your primary residence or a qualified second residence is tax-deductible up to certain limits. Clear documentation is required: renovation contracts, itemized receipts, invoices, and bank statements showing payments to contractors that prove the use of funds.

Pros

• Lower interest rates.
• Flexibility.
• Interest paid only on the amount withdrawn, not on what you are approved to borrow.

Cons

• Variable rates (higher than mortgage rates).
• Equity determines borrowing limits.
• Risk of foreclosure because the home is collateral.

On April 27th, Bankrate reported that interest rates on a $30,000 HELOC dropped to 7.81%. That is the lowest level seen in two years among their national survey of lenders.

The diagram below can help you consider all of the options and make a wise choice on how to pay off this credit card debt.

Honest Casa Diagram

Financial slave 

The Bible never declares that debt is sin. However, Proverbs 22:7 says, “The borrower is servant to the lender.” I don’t want you trapped in a never-ending cycle, juggling the weight and stress of your debt. Choose the best path forward and seek to avoid any new consumer debt in the future.

Extra reading

• Should I Take Out a HELOC?
• Fraud Protection.
• Red Flags.

Consider reaching out to Christian Credit Counselors. They are a trusted partner of Crown and can help you create a debt management plan tailored to your current needs—putting you on a path toward financial freedom.