Rolling card debt into a home loan not always wise
By Allie Johnson
February 17, 2016
Your home sweet home could give you shelter from credit card debt woes, but think carefully before rolling your credit card balance into a home loan.
While using a mortgage refinance or home equity loan to turn high-interest debt into low-interest debt works for some, there are several big pitfalls — and some pluses — to consider before you sign on the dotted line.
For example, Colorado money coach Matt Kelly and his wife racked up double-digit credit card debt and rolled it into home loans four times before realizing they were signing away the home equity they had built up to enable their overspending.
The biggest problem: They were in denial about unexpected expenses that inevitably crop up in any given month. “Finally, we realized cars break down, and dogs go through screen doors,” Kelly says. Once they started saving for those costs and living within their means, they stopped racking up credit card debt, he says.
“The key is to recognize it’s not a solution, it’s just a Band-Aid,” Kelly says of refinancing credit card debt.
Can a home loan get you out from under credit card debt?
There are two main ways to use a home loan to get out from under credit card debt.
First, you can refinance your home, upping the total amount you owe and taking cash out to pay off your credit card debt. This is generally a bad move, says Pam Horack, a fee-only financial planner who calls herself “Your Financial Mom.”
That’s partly because it doesn’t make sense to take 30 years to pay off $2,000 in credit card debt, she says. “It’s a mismatch,” she says.
Also, a mortgage refinance typically requires you to pay closing costs.
“If it’s a small amount of credit card debt, it’s probably not going to make a huge difference.”
— Cara Pierce,
a housing financial specialist, on tax advantages of funneling card debt into a mortgage
A second option, a better one, is to take out a home equity loan or line of credit, a separate loan you can pay off in a shorter time frame, Horack says. “You can pay it off early,” she says. Also, you typically do not incur closing costs with a home equity loan, but there are fees involved.
The biggest plus to using a home equity loan or line of credit to pay off credit card debt is that you turn higher interest debt into lower interest debt, which can allow you to pay off your balance faster and save money, Horack says.
Funneling credit card debt into a first or second mortgage also may provide a tax advantage if you itemize deductions when filing your income taxes, says Cara Pierce, a housing financial specialist with Clearpoint Credit Counseling Solutions. However, you’d need to consult a tax pro about your specific situation, she says. “If it’s a small amount of credit card debt, it’s probably not going to make a huge difference,” she says.
But before you decide that paying off your card debt with a home loan sounds like a great deal, look at these minuses:
- You might not qualify. In order to get a home equity loan or line of credit, you need to have decent credit, enough equity in your home and a low enough debt-to-income ratio to satisfy the bank, Horack says.
- You’re securing unsecured debt. Taking unsecured credit card debt and securing it with your home can be risky, Pierce says. With the new debt added in, your house payment may increase, which could make it more difficult to pay if you hit hard times. “If something horrible happens in life — the death of a breadwinner, a layoff from your job — you’re risking your house,” she says.
- You could be tempted to overspend. If you’ve got spending issues and your credit card balances suddenly go down to zero, you might start spending on plastic again unless you’ve addressed your underlying financial issues, Horack says. And if you have a home equity line of credit, rather than a home equity loan paid in installments, you could rack up more debt on that, too. “It’s kind of like a credit card on your house, and that’s a little scary,” Pierce says of HELOCs.
Alternatives to securing your credit card debt with your home
Before you decide to roll your credit card debt into a mortgage refinance or home equity loan or line of credit, consider these other options:
A debt management plan. If you’re overwhelmed by credit card debt, consider visiting a credit counselor at a reputable agency, such as one affiliated with the National Foundation for Credit Counseling. First, the counselor can help you create a budget, or tweak the one you have, to fix the root problem that led to the credit card debt, Pierce says. The agency also may be able to get you into a debt management plan (DMP), she says. In a DMP, the agency may be able to call your creditors and negotiate lower interest and a lump sum affordable monthly payment on your debts. Every situation is different, but on average, a DMP cuts interest in half, Pierce says. “It might be a better alternative that doesn’t risk your house,” she says.
A balance-transfer deal. If you qualify, a 0-percent balance transfer card may help you get a handle on high-interest card debt, Horack says. If you go that route, it’s smart to pay down the debt as quickly as possible during the introductory period before interest kicks in, she says.
You can also decide to forgo the refinancing altogether, tighten your belt, sell unused items on Craigslist or eBay and possibly get a second job until the debt is paid off, Horack says.
“You’ve got to plan to attack the debt and get it under control,” Pierce says.