When you get see your monthly credit card statements and the interest you’re paying, does it feel as if the financial roof is about to cave in?
If so, the real roof over your head may provide the best way to eliminate credit card debt.
You can get a home equity loan or home equity line of credit, which is commonly referred to as a HELOC, and pay off the credit cards. The interest rates will be so much lower than credit cards you’ll probably be able to buy a new Spanish tile roof.
Qualifying is almost too easy since the only thing you really need is a house with some equity. Equity is the market value of your house minus any remaining mortgage payments. Simply put, if your house is worth $300,000 and you owe $97,000, you have $203,000 in equity.
You will also need to have a minimum credit score of 620, but the best interest rates and terms will be for those with a score about 740.
Finally, you may need a small amount of cash reserves that show you can make 2-4 months of payments on your mortgage and your home equity loan.
There’s a lot of equity out there. A 2016 study found that U.S. homeowners are sitting on almost $7 trillion in home equity. That would be enough for each owner to pull out $150,000.
Most lenders require you to have at least 20% equity in order to get a home equity loan or HELOC. So if your house is worth $250,000, you’ll need to have made at least $50,000 in mortgage payments on the principal.
Banks generally allow you to borrow 75% to 85% of your home’s equity. As with all borrowing, your credit history matters. If your credit score is below 620, chances are you’ll get turned down for a loan.
If you qualify, your interest rate will be tied to your credit score. But whatever your score is, you’re all but guaranteed to get a lower interest rate than what VISA or Discover or American Express is socking you for.
The average APR for new credit cards was 15.18% in August of 2016.The average for applicants with poor credit scores was 22.56%.
You could find interest rates as low as 2.99% on home equity loans and HELOCs at this time. Interest rates fluctuate, but the average on a home equity loan was about 5%. What does that mean in real dollars?
Say you have $20,000 in debt spread over four credit cards, and the average interest is 15%. To pay that off would require 10 years worth of $323 monthly payments.
Then suppose you get a $20,000 home equity loan at 4.79% interest. Your monthly payments for 10 years would be $210.48. That would add up to $13,502.40 in savings.
You don’t have to be an Ivy League mathematician to see which debt management strategy makes more sense. It does take some thought, however, to decide whether a home equity loan or HELOC is the best way to go.
The loan is basically a second mortgage. You get a fixed interest rate for the life of the loan, which is generally 10 to 15 years. Homeowners generally choose these loans if they have a specific project in mind that has a fixed cost.
Most think of home improvements, but credit card debt certainly qualifies as a project worth tackling in one fell swoop.
A HELOC is more like a credit card, minus the harrowing interest rate. HELOC rates are almost always variable, meaning they are based on the Prime Rate plus usually 1% or 2%.
The Prime Rate in mid-2016 was only 3.5%. It hasn’t been above 10% since 1990, so even with a volatile world economy, the prime will probably never get as high as credit card interest rates.
And with home equity loans, banks will generally give you a line of credit up to 85% of your equity with a HELOC. But instead of a lump sum, your line of credit will have a maximum borrowing limit you can draw on for a fixed period, generally five to 10 years.
The only payment you’re required to make during that time is on the interest, and that’s usually a tax-deductible expense. When the draw period ends, you have to start paying back the principal and interest in monthly installments. The repayment period is generally 20 years on a 10-year HELOC.
From a saving standpoint, both home equity loans and HELOCs beat making monthly credit card payments. But both should come with a Surgeon General’s Warning:
“Caution, This Product Can Lead To More Debt.”
You’re not getting rid of debt. You’re simply moving it to a more sensible place. It can feel as if you’ve wiped the slate clean, but not if you fall back into the credit card spending cycle that got you into trouble in the first place.
That’s why it pays to consider alternatives like a debt management plan that consolidates credit – before getting a home equity loan or HELOC. Non-profit credit counseling agencies can consolidate your debt, get you a lower interest rate and counsel you on how to eliminate debt for good.
And with a debt management plan your house won’t be used as collateral. That’s a big reason why interest rates on home equity loans and HELOCs are so much better than what credit cards offer. If you default, the bank can claim something very valuable to you.
So as attractive as HELOCs and home equity loans are, be cautious. The only thing worse than having a creaky financial roof is to have no roof at all.
(Ebeling, A.)(2016, Mar. 31). Your Neighbor got a HELOC, Should You? Retrieved from http://www.forbes.com/sites/ashleaebeling/2016/03/31/your-neighbor-got-a-heloc-should-you/#7d03eb111637
(Li, W., Goodman L.)(2016, July 14). U.S. Homeowners are sitting on $7 trilling on spendable housing wealth. Retrieved from http://www.urban.org/urban-wire/us-homeowners-are-sitting-7-trillion-spendable-housing-wealth
(Goldstien, D.)(2016, July 14). The best ways to tap the equity in your home. Retrieved from http://www.marketwatch.com/story/the-best-and-less-best-ways-to-tap-the-equity-in-your-home-2016-04-01