My husband and I want to obtain some money to
pay off credit debt and also upgrade our home that we purchased
six months ago. My question is: Which would affect our credit score
more, a HELOC or to refinance our first and second mortgage loans
into one loan and use some of the equity to do this? Someone told
me that a HELOC looks like a big credit card debt.
-- Lisa Loanable
You're not paying off credit card debt when you take out a loan to
fund the payoff; you're just restructuring the debt. Debt restructuring
can make sense if it reduces the interest rate on the debt or spreads
it over a longer time period. Since credit card debt doesn't have
a defined maturity, you're looking to reduce your effective interest
rate. Besides having a lower interest rate, the interest expense on
a home equity line of credit may generate a tax deduction, moving
the effective rate even lower.
That said, I'm concerned that you've only owned this
house six months, you already have a first and second mortgage,
and you're looking to tap your equity yet again to restructure your
credit card debt and renovate the home. A HELOC would actually be
a third mortgage, with the first and second mortgage having priority
in a default situation. Sitting third chair instead of second will
make the HELOC a riskier loan with a higher interest rate.
A cash-out refinancing of the existing first and second
mortgage can get you past the third mortgage issue, but the closing
costs on a first mortgage are going to be substantially higher than
a HELOC. Let's just say that it's an additional $3,000 to do a cash-out
refinancing. That's money that could be going toward paying down
your credit card debt or funding the upgrades on your home. You
need pretty compelling reasons to refinance when you're only six
months into a mortgage loan.
Trying to decide which method of financing will best
protect your credit score is a little backward. You need the good
credit score to get the best financing now. Worrying about the loan's
impact on your credit score going forward means you're anticipating
the next loan. After six months and a potential third visit to the
mortgage markets, you should plan on taking a breather.
Getting back to your actual question, a HELOC doesn't
look like a big credit card debt because it's backed by a security
interest in your home. As long as you haven't forayed into borrowing
more than your home is worth with a 125-percent loan-to-value HELOC,
the equity backing of the secured debt isn't as risky as a like
amount of unsecured debt.
The HELOC and credit cards are alike in that they
are both lines of credit and the size of the lines and the amount
of available balances will impact your credit score. Using a HELOC
to restructure your credit card debt will free up available balances
on your credit cards, but having a third mortgage isn't likely to
help your credit score.