Periodically, The State’s financial columnists, Ashleigh Brooker and Neil Brown, certified financial planners in the Midlands, will offer their views on a question from a reader. This week’s question:
Should I refinance my home and/or take out the equity to pay off my credit cards?
I heard this question more often during the height of the real estate market, but not in recent years. The primary reason being, many of the same people who had equity in their homes five years ago have significantly less, if any, today. However, with today’s interest rates being at historic lows, refinancing into a lower rate and/or for a shorter term can significantly lower your borrowing costs. While refinancing your home makes sense in many cases, I am not a fan of using the equity in your home to pay off your consumer debt.
I primarily do not recommend it because it often gives the consumer a false sense of their true financial condition. Consequently, debts that have nothing to do with your home, which in many cases is a family’s biggest and only asset, are now associated with that house. Reducing the equity in your home may not seem like a big deal at the time of refinancing, but it can be a huge deal if you decide to sell your home in a weak real estate market. No buyer cares what you owe the bank. Instead, they only care about the market value of your property, and a wise buyer will not pay a penny more. Given that you only net the difference between the selling price and the debt, the more debt you have associated with the house, the less you net.
The bigger problem that I notice is that the lower monthly payments for the newly consolidated debts create the illusion of a pay raise. Unfortunately, many people return to their same financially unhealthy habits instead of applying the extra cash to other financial goals or accelerating their debt repayment. For the undisciplined consumer, it is easy to find yourself in a worse position than what initially led you to try this strategy.
There are a limited number of times where using a home equity line or rolling debt into a mortgage may make sense. For instance, an individual has accumulated too much credit card debt at very high rates. Transferring this debt to a home equity line of credit could prove beneficial in simply lowering your interest rate. This assumes the consumer has the discipline to not simply make the minimum payments, but to pay down this debt quickly. Making minimum payments or rolling this debt into a newly refinanced mortgage, can make that $1,000 TV cost $1,500 to $3,000 depending upon the method of transfer.
Another, albeit weak, reason to consolidate one’s credit card debt into an equity line of credit is taxes. In using an equity line of credit, which is secured by your home, you have turned nondeductible credit card interest into deductible mortgage interest. While the tax law can be complicated, the basic rule allows one to deduct the interest associated with the first $100,000 of equity debt. The negative in this is that you have now pledged your home as collateral. If you experience payment difficulties, this pledged collateral can be taken from you.
While an argument can be made to use your equity line to reduce your interest rate and your taxes, I must agree with Ashleigh in that this should be avoided by spending wisely in the first place.
Ashleigh Brooker, CFP, is the principal of A. J. Brooker Financial Associates in Columbia. Reach her at info@AJBrooker.com or (803) 724-1235. Neil A. Brown is a CPA and CFP with Burkett Financial Services in West Columbia. Reach him at uscneil.com or (803) 200-2272.