Credit card debt can be difficult to manage, even under the best economic conditions. But in today's inflationary environment, it can be particularly challenging. Many Americans are even turning to their credit cards and taking on additional debt just to make ends meet or to cover unexpected expenses.
To that end, The New York Fed reports the total credit card debt in America rose to the tune of $154 billion (4.7%) to $1.08 trillion during the third quarter of 2023. That marks the largest increase on record.
Repayment strategies like the debt avalanche and debt snowball methods can be effective methods to pay down your credit card debt.and can also help. And, if you're struggling to eliminate your credit card debt, are another option with unique benefits worth exploring.
How a home equity loan can help you eliminate credit card debt
There are a few ways that home equity loans can help you eliminate credit card debt, including:
They have significantly lower interest rates than credit cards
Perhaps the biggest advantage of using a home equity loan to pay off credit cards is the cost savings they may offer. According to the Federal Reserve, the average credit card interest rate is currently 22.77%, with many cardholders paying rates over 30%. By contrast, average home equity loan rates for 10- and 20-year terms are 8.09% and 8.16%, respectively.
Because home equity loans are second mortgages secured by your home, the lender carries less risk, which translates tofor borrowers. For this reason, home equity loans are often used to consolidate high-interest credit cards, which could provide you with substantial savings over time. However, be aware that your lender could foreclose on your home if you fail to repay your loan.
One loan is easier to manage than multiple credit cards
A home equity loan can also make it easier to manage your debt by combining all of your credit card accounts into one loan. Rather than juggling multiple credit card accounts and payments, you may prefer the simplicity of making one payment to one account with one due date and one fixed interest rate.
Streamlining your credit card accounts into one loan may make it easier to manage your payments and reduce the likelihood of missing a payment. Not only can consolidating via a home equity loan make budgeting easier, but the lower interest rates could save you money over time and accelerate your debt payoff timeline.
There are possible tax benefits
A home equity loan could make sense if you plan to use some of the funds to make meaningful improvements to your home. According to the IRS, you may qualify to deduct interest from home equity loan or home equity line of credit (HELOC) funds that you use to "buy, build, or substantially improve the residence," subject to certain limitations. However, you may not deduct loan interest for funds you use to pay off credit card debts or other living expenses.
So, for example, if you have $10,000 in high-interest credit card debt and are planning a $20,000 kitchen renovation, a $30,000 home equity loan may serve both of your needs. You may then qualify to deduct interest on the $20,000 portion you use to improve your home.
A home equity loan could positively affect your credit
Consolidating several high-interest credit cards into one home equity loan could potentially improve your credit by lowering your credit utilization ratio. This ratio measures the amount of available revolving credit you're using, and it accounts for 30% of your FICO credit score. Generally, the lower your, the better your score. Consumers with high credit scores often have ratios below 10%.
Additionally, a home equity loan could improve what's known as your "credit mix," which makes up about 10% of your credit score. Credit scoring models usually like to see that you are good at managing several types of credit, such as an auto loan, student loan, credit card and mortgage.
How to compare home equity loan options
Before you compare home equity loan lenders and offers, determine how much equity you have in your home by subtracting your current loan balance from the market value of your home. Remember, you'll need roughly 15% to 20% equity in your home to qualify for most home equity loans.
Here are some key factors to consider to help youoption for your situation.
- Interest rates: Taking the time to shop and compare different lenders and loan offers is essential to finding the lowest interest rate available. Securing the lowest annual percentage rate (APR) on a home equity loan can help you reduce the total amount of interest you pay over the life of the loan.
- Loan term: Home equity loan terms typically range from five to 30 years. You'll usually make lower monthly payments with a longer term, but also pay more in total interest costs. Conversely, you'll likely have higher monthly payments with a shorter term, but your total interest costs are usually comparatively lower.
- Loan amount: Calculate how much money you need and look for a lender whose loan amounts match your needs. Home equity loans generally allow you to borrow up to 85% of your home's equity, but this may vary depending on your lender, credit, income and other factors. It's always wise to avoid borrowing more than you need, especially since your house serves as collateral on the loan.
- Closing costs and fees: As you perform your due diligence, remember to factor in on a home equity loan or HELOC. These costs typically range from 2% to 5% of the loan amount, which could offset a lower interest rate. Depending on the size of the fees, you could end up paying more for a loan with a low interest rate and high closing costs than a loan with a slightly higher rate and less expensive closing costs.
The bottom line
A home equity loan can be anto zero out credit card debt, but the decision to get one should be taken with great care. If your income is inconsistent or your long-term job outlook is unclear, a home equity loan could be risky, especially considering your home is on the line. On the other hand, if you can easily manage your loan payments and your job security outlook figures to remain strong for as long as you have your loan, a home equity loan could be a beneficial option.
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