As a financial planner, this is a question I am asked frequently. Often people consider getting a Home Equity Line of Credit (HELOC) or a personal loan to consolidate their credit card debt. Debt management is one of the biggest causes of stress for many people, so it’s understandable that those drowning in debt are looking for a solution. But…is this the right one? People seem to think this is an easy solution to their credit card problems, but there is no silver bullet. You still have your debt, you are just paying it off differently. Here are three things to consider before making this move.
- Will you continue to rack up credit card debt? This is number one for a reason. The most important thing to consider is whether or not you will actually change your debt behavior and habits. If you have high credit card debt because of a one time home improvement project, or a year where you were building a business – then your debt may be circumstantial and not due to a habit of overspending. Too often I see people who get a HELOC or personal loan to pay off all their credit card debt, only to continue racking up debt on their cards. If the behavior doesn’t change, you can end up in double your original debt – your loan plus the new credit card debt you recently added. This problem partly stems from the feeling of relief behind paying off your debt. All the sudden, you feel like you have ‘extra’ money to spend. Remember that this is not free money, and it’s not ‘your’ money. So before you get the loan, make a plan for success. Cut up all your credit cards, or make a rule that they are only for emergency. No one plans to rack up high credit card debt; it starts small and adds up so you must be vigilant. If you don’t plan to change your spending habits, do not even bother reading any further. This is not the solution for you. Do not pass Go. You will thank me later.
- Will you save money? If you have a credit card with a 28% interest rate, and you can get a loan with a 6% interest rate – odds are you’re going to save money by transferring your debt. But there are other things to consider. HELOCs generally have variable interest rates. The interest rate is based on a benchmark rate, such as the Fed funds rate, plus a margin, which is established by the lender. When interest rates go up, your monthly payment will go up. So make sure you understand the terms of your loan. Also, often the reason these options are appealing is because it extends your repayment terms to as many as 30 years, making your monthly payments smaller. However, the overall cost of your debt may increase even if your interest rate is significantly lower because you will be paying interest for a longer period of time. Use an an online debt consolidation calculator to compare the total amount you will pay.
- Will it help you make payments? One of the worst things you can do to your credit score is miss payments, or make late ones. When someone has multiple cards with multiple payments, it can be hard to keep track and sometimes payments are missed. A debt consolidation loan can be hugely beneficial in these situations by reducing your payments into one easy amount. Or, your credit card minimum payment may be so high that you simply can’t afford to make it some months. Again, getting a loan that allows a smaller, more manageable monthly payment may be a good option for you.
- Will you continue to rack up credit card debt? It’s worth listing again. In case you don’t remember from #1, if you think there is the tiniest of tiny chances you will be right back where you started with credit card debt, don’t use a loan or HELOC to pay off your credit cards. None of these benefits – lower interest rates, smaller monthly payments and convenience of one payment – will matter. You will end up with double the debt and much worse off then you are now. So be honest with yourself.
If you’ve read this article and you think this option is probably not right for you – you’re smart to realize this now. The first step is to change your spending and ‘debting’ habits. Once you’ve identified and are working on the problem, make a plan to get aggressive with your debt. You have two options to reduce your debt faster. One option is to cut from your budget, and allocate that amount to your credit cards. Another is to get a side gig, and put every cent you make there towards your debt payment. No silver bullet, but it can be done.