Paying Off Debt With a Home Equity Loan

Wipe Out DebtLenders sometimes advertise the benefits of paying off credit cards with the equity in a home.  I cringe when I see these advertisements because in most cases this is a truly terrible idea.  Credit cards are unsecured debt.  If you don’t pay your credit cards the lender may sue you and obtain a judgment.  That means different things depending on where you live.

Collecting on a judgment is limited by state law and the exemptions in the state in which you live.  In Texas we have a very good homestead exemption.  A homeowner is usually not at risk from losing their home to a judgment creditor, unless the creditor is an HOA, the IRS, a lender with a security interest in the home, or a property taxing authority.  Your credit cards cannot take your home.  However, when you take the equity out of your home to pay off your credit cards you are essentially turning that unsecured loan into a secured loan.  Now if you don’t pay that debt you will lose your house.

Borrowing against the equity in a house to pay credit cards means the borrower will be paying two mortgage payments for a very long time and most of that money will be going to interest.  Consider the amortization schedules on home equity loans and other mortgages.  Most of each mortgage payment goes to interest.  Each month a little more of the payment goes to the principal and a little less to the interest.  Because of the way mortgages and home equity loans are paid, debtors give up the equity in their home for a long time.  Home equity loans do not have the very low interest rates that a mortgage does.  They are higher although not as high as credit cards.

If the homeowner is eligible for bankruptcy then they should consider this alternative to paying off credit cards with a home equity loan.  Chapter 7 bankruptcy takes three to four months and discharges credit card debt with no payments.  Chapter 13 bankruptcy takes three to five years.  In the best cases debtors can discharge all credit card debt with no repayment.  In the worst cases the debtor has to pay back the balance owed with no interest.  In either situation the debtor is still much better off than if they were to use their equity to pay their credit card debt.