Using a Home Equity Loan to Pay Off Credit Card Debt: Will You Really Benefit?

Home equity loans allow you to borrow against the equity you've built in your home to pay off debt. Interest rates are usually reasonable and sometimes any closing or other fees you'd normally pay on a mortgage loan are waived. If you have high-interest credit cards, the lower interest offered by a home equity loan can significantly reduce your finance charges.

Equity loans are attractive because, in most cases, the interest can be written off on your income tax return like mortgage interest. However, there is a huge caution here: do not apply for a loan that is higher than the equity you have in your home. You cannot write off the interest on your tax return if the amount you owe on your home is more than its value.

You may have received offers through the mail for loans at 125% of your home's value. While it seems like the answer to your problems, it's not the best choice for someone trying to get out of debt. By tying up your home and an extra 25% in a loan, you have the potential to lose your house, plus another quarter of its value, if for some reason you can't pay.

Reputable banks will normally allow you to borrow a maximum of 80% of your home's equity. An appraisal may be required if one hasn't been done in the last several years. Similar to when evaluating new credit card accounts, you need to compare the loan's interest rate and additional loan charges (if any) against what you're already spending to service your credit card debt.

Confirm that the lenders you consider accept prepayment of principal in case you later decide to bump up your monthly payment amount. If you're comfortable with exploring the Internet, many reputable online lenders offer better rates than banks.

Let's say you have:

A $5000 Visa balance at 15% interest
A $3000 department store card balance at 21% interest
A $2000 MasterCard balance at 18% interest

Ideally you need to lower the rate on all your debt. Let's say that you find a lender who charges 11% interest and a $750 origination fee. Some lenders will allow this fee to be financed along with your loan. After evaluating your situation you discover that you only have $6000 equity in your home.

Instead of paying a little on each of your three balances, fully pay off the 21% and 18% cards at a total of $5000. $750 of the remaining $1000 covers the fees. It's your decision whether to borrow the remaining $250 and apply it to your Visa balance.

Always fully investigate the terms of any consolidation loan you are considering, including principal amount, interest APR, number of payments, and additional fees - and get it in writing. Many lenders advertise a guarantee of lower monthly payments that sounds too good to be true, and sometimes it is.

They may charge a high interest rate but the length of the loan can last for much longer than normal, and that's how they get away with advertising low monthly payments. Be especially wary of lenders who send you checks in the mail offering to loan you great sums of money by simply endorsing the check, as well. These offers are best thrown in the trash.