If you have large outstanding balances on one or more credit cards, you may be struggling to bring your debt level down. If you're only able to make minimum monthly payments, it could take years, if not decades, to zero out your cards. One alternative, if you own your home, is taking out a home equity loan and using the money to pay off your card debt. But before you do, you'll also want to consider the risks and some possible alternatives.
- A home equity loan is one way to pay off credit card debt.
- Home equity loans generally charge much lower interest rates than most credit cards.
- The danger of a home equity loan is that you could lose your home if you are unable to repay it.
What Is a Home Equity Loan?
A home equity loan allows you to borrow against the equity that has accumulated in your home over the years. For example, if you own a home that's currently worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in equity.
Based on that, a bank, credit union, or other lender may be willing to issue a home equity loan equal to some percentage of your equity. How much you can borrow, and whether you can get a loan at all, will also be affected by other factors, such your credit score.
Advantages of Using a Home Equity Loan to Pay off Debt
The principal advantage of using a home equity loan to pay off credit card debt is that you'll generally obtain a much lower interest rate than you are paying on your credit cards. At this writing, for example, the average interest rate on a home equity loan is just under 6%, while the average credit card in Investopedia's database is charging more than 19%.
If you use a home equity loan to pay off multiple credit cards, it will also simplify your life, giving you just one bill to deal with each month instead of several.
Note that one former advantage of home equity loans has been suspended, at least for the next several years. At one time, the interest you paid on a home equity loan was tax-deductible, while credit card interest was not. Now, however, as a result of the Tax Cuts and Jobs Act of 2017, the interest on home equity loans is deductible only if you use the loan to "buy, build, or substantially improve" the home that secures the loan. That provision is slated to remain in effect at least until 2026.
Drawbacks to Paying off Credit Card Debt With a Home Equity Loan
The major downside to taking out a home equity loan—to pay off debt or for any other purpose—is that you'll be putting your home on the line. Because your home serves as collateral for the loan, just as it does for your original mortgage, the lender could seize and sell it if you are unable to pay your loan back.
When you can't repay credit card debt, you'll also face serious financial consequences, of course, especially to your credit score. But because credit card debt is not secured by your home, you'll be at far less risk of losing it. Even if you have to declare bankruptcy because of your debts, you can often keep your principal residence.
Other Ways to Pay Off Debt
A home equity loan is not your only option when it comes to paying off credit card debt. A few others you might consider:
Transfer Your Balances to a Lower-Interest Credit Card
Some credit cards allow you to transfer your balances over from other cards. This can make sense if you're able to obtain a significantly lower interest rate on the new card. Many balance transfer credit cards also have promotional periods, often six to 18 months, when they charge 0% interest on the transferred balance. Moving a balance from one card to another won't eliminate the debt, of course, but it can help you pay it off faster.
Take out a Debt Consolidation Lloan
A debt consolidation loan from a bank, credit union, or other reputable lender could provide the money you need to pay off your credit card balances. Debt consolidation loans tend to charge significantly lower interest rates than credit cards.
Borrow From Your 401(k) Plan
Many 401(k) plans allow you to borrow from the money you've accumulated in your account. If your plan has such a loan provision, you may be able to borrow as much as $50,000. What's more, the interest you pay on the loan goes back into your account. Loans from a 401(k) do have a few caveats. For one, the loan generally needs to be repaid within five years, or sooner if you leave your job. For another, if you're unable to repay the loan, it will be treated as a withdrawal, subjecting you to income taxes and a possible 10% penalty on the unpaid balance.
The Bottom Line: Is a Home Equity Loan the Answer to Getting Out of Debt?
A home equity loan can be a good way to pay off high-interest credit card debt—if everything goes according to plan. However, worst-case scenario, it can also cost you your home.
In deciding whether it's a viable option, consider how strong—or precarious—your financial situation currently is. If you have a secure job (and/or a spouse with one) and are confident that you'll have no trouble keeping up with the payments, it could make sense. However, if your job is on shaky ground and you have no other financial resources to draw on if you lose it, a home equity loan could be a risky proposition.