Moving your debt from a credit card to a home equity line of credit, or HELOC, can substantially decrease the amount of interest you pay. Because a HELOC is secured by collateral — your home — it represents a smaller risk to lenders than other types of loans. That means a lender typically will let you borrow at an interest rate much lower than you would find on a credit card, which is often unsecured.
But using a HELOC to pay off credit card debt also involves serious risks and should not be taken lightly, says Bruce McClary, vice president of communications for the National Foundation for Credit Counseling and U.S. News contributor. Defaulting on a HELOC can put your home in jeopardy, and some people who move their credit card debt to a HELOC may see a newly cleared credit card ledger as an invitation to begin running up more debt.
“Using a home equity line to consolidate credit card debt can make sense in some situations,” McClary says. “But it’s always better to consider the alternatives first.”
[Read: Best Low-Interest Credit Cards.]
Why Move Credit Card Debt to a HELOC?
Shifting credit card debt to a HELOC can dramatically reduce the interest rate on your debt. For example, the average APR on a HELOC nationwide is less than 6 percent, compared with an average APR of about 17 to 24 percent for credit cards.
Because HELOC rates can be so much lower, moving your debt to a HELOC can substantially lower the cost of your debt burden. “The potential for savings can be significant,” McClary says.
Consolidating the debt on multiple credit cards into one HELOC payment also can be a huge advantage for people who have a lot of credit cards, says Linda Jacob, a financial counselor at Consumer Credit of Des Moines in Iowa. Jacob says she has had clients with as many as 27 credit cards. “The sheer coordination of payments and keeping them current can be overwhelming,” she says.
By contrast, moving the debt from multiple credit cards to a HELOC gives you just one monthly payment to keep track of.
Why Not to Move Credit Card Debt to a HELOC
Despite these advantages, moving debt from a credit card to a HELOC can be dangerous if you’re not careful.
HELOC interest rates are relatively low because the loan is secured by collateral — namely, your home. Default on the HELOC, and you might pay a steep price.
“I think this is where the caution light comes on,” McClary says. “You could lose your home. So the stakes are much higher.”
Moving your debt to a HELOC also can be a problem if you are unable to rein in your spending. Some borrowers can’t resist running up new debt on their credit cards once the slate has been wiped clean, McClary says.
The worst-case scenario, he says, is that “you could end up doubling your debt and then be in a worse situation. Because now if you tapped out the equity in your home, and you’ve maxed out your credit cards, you’ve got nowhere to turn.”
Because of the risks, McClary says he generally does not encourage people to move credit card debt to a HELOC.
“You’re only putting a Band-Aid on the situation if you’re not addressing the longer-term issue, which is your ability to manage your debt,” he says. You should also examine underlying budget issues that might lead to debt, such as overspending or earning inadequate income.
Alternatives to Moving Debt to a HELOC
A HELOC is not your only option to pay down unwieldy credit card debt. McClary encourages consumers to explore other choices, including transferring the debt to a new credit card. This works best if you have a healthy credit score and solid overall finances.
“Consider looking at more competitive credit card offers that will allow you to transfer balances,” he says.
Look for cards that offer a zero percent APR for an introductory period, which is usually 12 to 18 months. HELOCs may offer longer repayment terms — even 20 years — but you don’t necessarily want to drag out payments on credit card debt for that long. You can save much more on interest if you pay off most or all of your debt during the interest-free introductory period on a balance transfer card.
Todd Christensen, education manager at Boise, Idaho-based credit counseling agency Debt Reduction Services, is also reluctant to suggest moving credit card debt to a home equity line of credit. “I’m just not a fan,” he says. “What I tell people is, ‘You are now putting your home at risk if you can’t make the payment because of pizza you put on your credit card last month.'”
Instead of a HELOC, check to see whether your credit card issuer will agree to lower your rate, Christensen says. “A lower interest rate typically means lower monthly payments, and more affordable,” he says.
Credit card companies are more likely to drop your interest rate if you have a history of making payments on time for at least a year, Christensen adds. “If they look like a high risk to the lender — maybe they’re maxed out, or they’ve gone over their limit — it’s less likely to happen,” he says.
Another alternative is simply to begin paying off your credit card debt more aggressively. Christensen describes this as doing it yourself instead of relying on a HELOC. He suggests taking 10 percent of your discretionary expenses — costs you can control, such as spending on groceries, meals out and entertainment — and using that money to accelerate debt repayment.
A debt consolidation loan from a bank, credit union or online lender is another option for moving credit card debt, McClary says. The interest rates could be lower than what you’re paying on your credit card, although probably not as low as a HELOC. Not all debt consolidation loans require collateral, but if you choose a secured debt consolidation loan, you will have to pledge an asset such as your home, vehicle or savings account.
Christensen agrees that debt consolidation loans can make sense for some people. However, he adds that such loans are “not easy to come by sometimes. Lenders aren’t always superthrilled about taking on other lenders’ risks.”
A nonprofit credit counselor, though, is readily available and can set up a debt management plan for you. A credit counselor can help you budget payments, propose payment plans to your creditors and make payments on your behalf until your debt is paid off.
Like a HELOC or a debt consolidation loan, debt management plans usually have a cost. You can expect to pay a one-time, small setup fee and a monthly fee of about $25 to $60 for a debt management plan.
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Is a HELOC a Smart Way to Pay Off Credit Card Debt? originally appeared on usnews.com