 Trading
credit card debt for home equity debt
|  Dear
Steve,
I have about $12,000 in debt and $25,000 in home
equity. The number of cards and load are hurting my credit. I learned
my lesson regarding debt and now have been fighting to pay these off.
Should I go for the home equity line of credit, or will the interest
kill me? -- Brian
 Dear
Brian,
The problem you are faced with is one that faces
many of today's consumers. Lenders make those home equity lines
of credit sound so wonderful that it becomes easy to forget that
you could end up much worse off than you were before.
I'm going to answer the second
part of your question first. Credit cards generally carry a higher
interest rate than a home equity line of credit. Although you did
not say this, I assume that right now the interest on your cards
is very high if you are looking to pay them off through this route.
So theoretically, the interest shouldn't "kill" you, since
the amount you will pay in interest should be lower than before.
As of this writing, the overall
average interest rate is 12.55 percent for variable cards and 11.31
percent for fixed-rate cards. Rates on equity products are much
lower -- 7.2 percent for fixed-rate home equity loans and 6.74 percent
for variable-rate home equity lines of credit.
If you decide to borrow from your
home equity I suggest a fixed-term loan, not a home equity line.
Before you take this step, be sure you have a spending
plan in place that allows for you to pay off the loan in accordance
with your overall financial goals. If you don't have any goals,
get some first. Then carefully track and record your expenses, and
create a budget you can live with. Pay your bills on time to avoid
fees and penalties. Don't neglect your savings.
An added benefit of home equity
borrowing is that the interest you pay on an equity loan or line
is often tax-deductible
while credit card interest is not. This could be an advantage for
you at tax time. What may kill you is that with only $25,000 of
equity, if the value of your home should drop, even a little, you
could be upside down in your mortgage. This means you won't be able
to sell the house to either downsize, upsize or pursue a job opportunity
in another area without coming up with some serious cash.
That's not the only issue -- if
you only have $25,000 left in equity, you may not be able to get
an equity loan at all. Most lenders don't allow home equity borrowing
if it would take you past 80 percent of the home's value. For example,
if your home's value is $125,000, then 20 percent of it is $25,000,
and you have no equity remaining that is "loanable" against,
because your loan to value, or LTV, ratio is right at 80 percent.
A few lenders go beyond that mark, but these "high
LTV" lenders charge higher rates.
You mentioned you have a high number
of cards with balances. This is one of the factors used by the Fair
Isaac Corporation to create your FICO score, and you are correct
in saying it may be affecting your score. While I understand what
you are trying to do, you need to be careful about closing too many
accounts at once. This can also adversely affect your FICO score.
It doesn't matter how many cards you have; what matters is the number
of cards with balances. Having low or zero balances will help your
score, however, so you should keep some of them open. If terms are
generally the same, I recommend that you keep those accounts you
have had for the longest period of time. This will also help with
the scoring issue.
I always caution against trading
an unsecured debt (your credit cards) for a secured debt (your home
mortgage), which places your home at risk. The reason these secured
loans have better terms is that the lender now has a right to your
home should you default on the loan. Some consumers going this route
have found themselves worse off than before because they did not
change their spending habits and continued to use credit as before.
By following these steps and building
your savings, you should be able to avoid repeating your mistakes
and can truly win your fight against debt.
Good luck!
The
Debt Adviser, Steve Bucci, is the president of Money Management International
Financial Education Foundation. Visit MMI
for additional debt
advice or click here
to ask a debt question. | 
