Most of us can run up credit card debt without even knowing exactly
how we did it.
We look at that statement with the big numbers and
try to remember where the money went. A few dinners here, some clothes
there, a short weekend getaway, late charges and, finally, over-limit
fees. Then, add lots of interest that your parents used to be able
to deduct from their taxes but you can't.
What makes it worse is when you're on a fixed paycheck,
it's difficult to pay off that debt incurred in good times past.
The best solution is to get a clean break by rolling that debt into
a home equity loan.
Make improvements that add to the value and enjoyment
of the home.
the good life that you incurred on the plastic you carry in your wallet.
Most home equity loans are taken either to:
If you are borrowing to build a new kitchen, you feel
OK about the borrowing because you know you're adding value to your
home. And if you end up with a new kitchen, perhaps you'll spend
less money in the long run on eating out.
when you're borrowing to refinance credit cards and consolidate your other loans,
the decision gets more difficult.
A lot of people find themselves
with far more credit card debt than they can handle. If you're in this situation,
start arranging to refinance the debt into a home equity loan.
In fact, if you're really feeling financially daring,
add enough money to get that boat you couldn't get when you were
maxed out on the credit cards.
That's a joke, but this isn't: Remember you're already
in debt with the credit card companies.
Refinancing's many benefits
Refinancing your debt into a home equity loan doesn't increase your debt. It doesn't
add a dime to what you already owe. It just moves the debt.
refinancing, you're shifting the debt from various credit cards with differing
due dates to one lender at a lower interest rate with a fixed repayment plan.
In addition to the convenience of consolidating payments and payment dates, you
create a tax benefit like your parents had before 1987, when they could write
off credit card interest on their taxes.
The major downsides to this strategy are that it leaves
you with refreshed credit limits on the plastic you carry in your
wallet and puts your home at risk if you don't pay. If you're not
careful, you will wind up facing the same problem down the road.
Actually, many years of practice tell me that most
people will wind up in the same place, because we don't change our
ways. However, at least by refinancing you've given yourself a break
and have for a period the psychological benefit of knowing that
you're credit card debt-free.
In addition, you'll have the
financial benefit of paying a lot less interest, not to mention the cash you'll
save by making the interest expense tax deductible.
also probably think harder about what you charge on your cards, so you don't have
to face this decision again.
When you get set to refinance
you'll want to find the right loan and also set a timetable for having the loan
paid off as soon as possible. When I say getting the loan paid off as soon as
possible, I mean at least paying off the old debt before you rack up another round
of credit card debt that you'll need to refinance.
equity loan vs. HELOC
For this reason, I recommend that if you're refinancing
debt, get a home equity loan rather than a home equity line of credit (HELOC).
A home equity loan is a fixed amount that you borrow to be
paid off over a certain number of months (I recommend 36, and no more than 60
A HELOC is like a bank account where you continue
to write checks on the equity in your home as opposed to writing the checks based
on actual money in the bank. A HELOC does not have a period in which it will be
paid off, since you can continue to borrow against it, similar to a credit card.
using these resources, you should figure out how much debt you have. Also figure
out how much you've been paying every month on these revolving debts.
say you have $25,000 in debt you've been paying $500 to $600 a month on, and the
amount of debt has been the same for a while now. If you refinanced that into
a four-year home equity loan at 7.23 percent, your monthly payment would be $601
and you'd get it paid off.
Of course, if you use your entire
budget to repay the home equity loan, it doesn't leave you any room for paying
the monthly minimum on future credit card charges. This means that those payments
will have to come from future raises or odd jobs until you've paid off the old
Use that tax break wisely
Actually, part of the payments should come from the reduced taxes you'll pay as
a result of deducting the interest on your taxes. In the first year of the loan
in our example above, the interest paid works out to $1,742. If your combined
federal and state marginal tax rate is 33 percent, your tax savings will be $575,
or $48 a month.
That sounds like a monthly minimum payment
on a new round of debt to me. Of course, you could stop spending. But how likely