High monthly credit card payments can make it difficult to reduce debt, especially when a significant portion of each payment goes toward interest. If you have built equity in your home, using a home equity line of credit (HELOC) to consolidate credit card balances may be an option.
A HELOC can potentially replace several credit card balances with one payment, but there is an important tradeoff: you are converting unsecured credit card debt into debt secured by your home. That makes it essential to consider both the potential savings and the additional risk.
How Does a HELOC Work for Debt Consolidation?
A HELOC is a revolving line of credit that allows you to borrow against available equity in your home. During the draw period, you can generally borrow up to your available credit limit, repay funds, and borrow again according to the terms of the account.
You can use HELOC proceeds to pay off eligible credit card balances. Instead of making payments to several card issuers, you would then repay the amount borrowed through the HELOC.
Most HELOCs have variable interest rates, so the rate and required payment can change over time. After the draw period ends, you enter the repayment period and can no longer borrow additional funds from the line.
Can a HELOC Lower the Cost of Credit Card Debt?
A HELOC may offer a lower interest rate than some credit cards, depending on current market conditions, your qualifications, and the lender's terms. If the HELOC rate is lower, more of your payment may be available to reduce principal rather than cover interest.
However, a lower interest rate does not automatically guarantee lower total borrowing costs. Compare the HELOC's rate, fees, repayment period, and expected payoff schedule with the cost of continuing to repay your credit cards.
Extending short-term debt over a much longer repayment period can reduce the monthly payment while potentially increasing the amount of interest paid over time.
What Are the Potential Benefits of Using a HELOC?
For homeowners who qualify and have a disciplined repayment plan, consolidating credit card debt with a HELOC may offer several advantages:
- One payment instead of several credit card payments
- A potentially lower interest rate than existing credit cards
- Flexible access to available credit during the draw period
- The ability to repay principal without following multiple card payment schedules
Paying down revolving credit card balances may also affect your credit utilization, which is one factor used in credit scoring. However, no specific credit score improvement can be guaranteed, and opening a new account or making other credit changes can also affect your credit profile.
What Are the Risks of Paying Credit Cards With a HELOC?
The most important risk is that a HELOC is secured by your home. Credit card debt is generally unsecured, while a HELOC gives the lender a security interest in your property. If you cannot repay the HELOC according to its terms, you could face foreclosure.
Other risks include:
- Variable interest rates: Your HELOC rate and payment may increase.
- Higher repayment payments: Payments can rise substantially when the draw period ends.
- New credit card debt: Paying cards to zero does not prevent you from using them again.
- Reduced home equity: Borrowing through a HELOC reduces the equity available for other purposes.
- Fees: Some HELOCs have application, closing, annual, early termination, or other charges.
The Consumer Financial Protection Bureau specifically cautions homeowners to consider alternatives before using home equity to consolidate debt because failure to repay can put the home at risk.
Is HELOC Interest Tax Deductible When Paying Off Credit Cards?
Generally, no. Current IRS guidance states that interest on a home equity loan or HELOC is not deductible when the proceeds are used to pay personal expenses such as credit card debt.
HELOC interest may qualify as home mortgage interest in certain circumstances when borrowed funds are used to buy, build, or substantially improve the home securing the loan and other tax requirements are satisfied.
Do not include a potential mortgage interest deduction when calculating debt consolidation savings if you plan to use the HELOC to pay credit cards. Consult a qualified tax professional about your individual circumstances.
Should You Close Credit Cards After Paying Them Off?
Closing every credit card immediately after consolidation is not necessarily the best approach. Closing an account can reduce your available revolving credit and may affect your credit utilization and credit profile.
On the other hand, leaving paid-off cards open can make it easier to accumulate new balances if overspending contributed to the original debt.
Consider the age of the account, annual fees, available credit, and your ability to avoid rebuilding balances before deciding whether to close or keep a card. The goal is to avoid ending up with both HELOC debt and new credit card debt.
What Are the Alternatives to a HELOC?
A HELOC is not the only way to consolidate debt. Depending on your financial situation, alternatives may include:
- Home equity loan: Typically provides a lump sum with a fixed interest rate and payment.
- Personal loan: Can consolidate debt without using your home as collateral.
- Balance transfer card: A promotional rate may provide temporary interest savings, but transfer fees and the rate after the promotional period should be considered.
- Cash-out refinance: Replaces your existing mortgage with a larger loan and provides cash from available equity.
- Debt management plan: A nonprofit credit counseling organization may help develop a repayment plan without borrowing against your home.
Compare total costs, repayment periods, interest-rate risk, fees, and whether your home serves as collateral before selecting an option.
Is Using a HELOC for Credit Card Debt Right for You?
A HELOC may be worth considering if you have sufficient home equity, qualify for favorable terms, can comfortably handle the payments if rates rise, and have a realistic plan to eliminate the debt without rebuilding credit card balances.
It may be a poor fit if your monthly budget is already strained, your income is unpredictable, or consolidating the balances would simply create room to take on additional credit card debt.
Before proceeding, compare the HELOC with alternatives that do not put your home at risk. Loan Wolf Lending can help Florida homeowners review available home equity and mortgage financing options. Call 754-755-3075 to discuss your options.