Tackling high interest debt
November 10, 2020 11:05 AM   Subscribe

Hi all, I went through a divorce a few years ago which put me in debt. I have about $25,000 in credit card debt. I am trying to figure out my best options: apply for home equity to pay down the debt or continue on covid19 mortgage deference and to use that money to pay down some of the debt (I'm unsure how long I can extend that for). I own my home, but the world of home equity or refinancing is very overwhelming to me. Thank you for your time.
posted by retrofitted to Work & Money (17 answers total) 2 users marked this as a favorite
In general, you want to pay the highest interest debt first. Since you have no other debt, you might be looking at a scenario where you trade one type of debt for a more advantageous type. In your situation, I'm guessing your credit card debt is a much higher interest rate than a home equity loan, so it might make sense to get a home equity loan, pay off all the credit card debt, and then make payments on the (much lower interest) home equity loan. Also, I believe that home equity loan interest is tax deductible, so that's another benefit.

There are a lot of factors that go into decisions like this - income streams/stability, other assets, etc., but in general this is the path that makes the most mathematical sense.
posted by _DB_ at 11:19 AM on November 10, 2020 [2 favorites]

I was in the same position when I got divorced - taking on £25,000 of unsecured debt. Part of it was a loan which had 2 years left to pay. Adding that to the mortgage made zero sense as I'd then be paying interest on it over 20-odd years, so I left that as it was. The remainder I put on a 0% credit card and paid down as much as I could each month. Then when the 0% interest period was due to run out, I transferred the remaining debt onto a new 0% card, and so on. I was ruthless about paying every last penny towards that debt It took me 2 years to pay it all off.

Turning unsecured debt into secured debt is cheaper in terms of yes, your monthly payment will go down. But long-term, it is way more expensive as you'll be paying interest on it for decades. If there's another way you can pay the debt down without securing it against your home, that should be your first priority.
posted by essexjan at 11:24 AM on November 10, 2020

Piggybacking on what _DB_ says above, if you're able to pay off a home equity loan over a short period of time - the same length of time it'd take you to clear the credit card debt - then that will definitely cost less than keeping the debt on credit cards, unless you can transfer the credit card debt onto a 0% deal.
posted by essexjan at 11:26 AM on November 10, 2020 [4 favorites]

What essexjan is talking about in her first post is called churning and many consider it to be a viable financial strategy - my biggest concern with it is the credit rating damage, but otherwise it may be a way to pay little to no interest on a balance.

One note regarding home equity loans - make sure you get one that has no early payment penalty, and just pay it down as fast as you can. They may give you 10+ years to pay it off but you want that balance gone ASAP. The goal isn't to convert your credit card debt to long term debt - the goal is to convert it from short term high interest to short term low interest debt.
posted by _DB_ at 11:34 AM on November 10, 2020 [6 favorites]

Another factor to influence the decision could be what your financial situation is right now: leaving aside the debt for a moment, are you in a fairly stable situation where your expenses are less than your income? if not, and you're heading deeper into debt -- it may not be the best idea to convert an unsecured loan (credit card) to a loan secured by your house, since that puts you at greater risk of potentially losing the house, whereas you could potentially default on your unsecured credit card debts while keeping the house if you kept the two debts isolated.

If your expenses are often or consistently higher than your income, that's the thing to triage and figure out how to turn around first.

Another idea: what interest rate are you paying for the mortgage? 30-year fixed rate mortgages have fallen by 0.8% since this time last year, again leaving aside the credit card debt, it may be possible to refinance the mortgage at a lower interest rate.
posted by are-coral-made at 11:54 AM on November 10, 2020

another sounding board for advice about personal finance are the boglehead.org forums -- they're mainly focused around low-cost, simple investment plans for retirement, but there's often also discussion about home loans, managing debt, etc. e.g. here's a thread with a similar question to yours: Home Equity Loan to pay off Credit Cards with high debt (bogleheads.org)
posted by are-coral-made at 12:04 PM on November 10, 2020 [1 favorite]

What's your current mortgage interest rate and how much equity do you have in your home? If your rate is in the 4s, the interest rate savings from a refinance might be enough to absorb the 25k. Try to keep the payoff time as close to what it was though; try not to take a mortgage that has 19 years left to pay and stretch it out over another 30 if you can help it.
posted by slidell at 12:28 PM on November 10, 2020

A first pass question would be -- what is your credit rating?

If it's good, then you can apply for a new card to churn to, a personal (bank) loan, or (combined with enough income) apply for a home equity loan. Good points made above against prolonging the debt over the mortgage term, and secured vs unsecured loan.

Any refinance will take this existing debt into account, too, you may get charged a higher rate because of it. But it still may be worth a call to a mortgage broker to see whether raters are a lot lower than your current mortgage.

If your credit rating isn't good, that changes strategy to debt consolidation and non-profit orgs that can help you plan your way out.
posted by Dashy at 12:28 PM on November 10, 2020 [1 favorite]

I'm trying to remember where I read this -I think it was in Elizabeth Warren's personal finance book. The advice was to never pay off unsecured debt with a home equity loan. If the shit really hits the fan (serious illness, unemployment, pandemic!), you are much more likely to lose your home.
posted by FencingGal at 12:29 PM on November 10, 2020 [1 favorite]

The issue with using your home equity is that many, many people get the home loan, get more than the absolute minimum loan they need, it's a lower payment, and all of a sudden the credit cards are maxed out again and let's get another home equity loan. They end up with a mortgage to pay off for a lot longer. So, be really disciplined, get a home equity loan at a low rate, pay off the cards. Keep 1 card with you, freeze the others in a block of ice for emergency use only, and carry on. Home loans have costs; you will likely have to have an appraisal, there are bank fees, title fees, fees for having fees, etc. You say you own the house, I presume that means mortgage-free; a small mortgage is a reasonable thing.

Go to your bank, which I hope is a credit union. Ask them to help you price a home equity loan. Get a 2nd credit union to give you their rates and costs. This is do-able, they're good at it.

Useful things to roll into a home equity loan: Do you have an emergency fund? Stuff happens and it's wise to have an emergency fund to cover 2 - 3 months of expenses. A line of credit might suffice. How's the roof? furnace? other repairs? Is your car likely to last a while? These are large purchases that are not so bad to borrow against the house for.

I got mortgage- and debt-free by reminding myself that debt-free feels better than more car than I need, new clothes I don't need, fancier vacations. Discipline is hard, setting a goal makes it much easier because I'm not giving stuff up, I'm gaining something.
posted by theora55 at 12:44 PM on November 10, 2020 [2 favorites]

I was going to ask a bit more about your picture too.

Mortgage deferral during Covid-19 - you said would "continue" on deference which makes me worry about your payment situation. Were you paying down the CC debt with those deferred payments already? If so, then I'm less worried, and I think a home equity loan without early penalty is a good way to go. Personally I would not defer any payments but I would pay down as much debt as possible.

If you can't make your mortgage right now, I would definitely NOT move the unsecured CC debt to your house because then you really do risk losing your home.

Job security - similarly, if you are worried about your job in the wake of the pandemic, I personally would focus on keeping my payments as low as possible. That is probably the only situation I would look to refinance the whole mortgage - it will extend your mortgage and lower your equity but it is probably the easiest way to keep all your payments low. However there will be mortgage penalties and that would depend on your particular mortgage and interest rate and everything.

Emergency fund - if you aren't renting you will definitely have expenses come up during the course of this loan. My worry is that if your minimum payment situation after you make this change is taking up all your disposable income you will end up with both the home equity loan and additional debt from all the "emergencies." So I personally would factor that in before paying off debt.

We incurred some debt, around $9k, at one point. What we did was a sort of middle ground, I don't know if it's available where you are. We got a line of credit that was secured against our house, so it had a lower rate of interest, but in terms of payments we had a lot of flexibility - the minimum payment was pretty small, in case our income went down (although we would have been in debt FOREVER paying it) but there was no penalty at all for paying it off. We cleared the debt fairly quickly (under a year.)
posted by warriorqueen at 1:06 PM on November 10, 2020 [1 favorite]

Look for a HELOC -- home equity line of credit. (As warrior queen says. The acronym is a common financial term and you can just ask your bank about it.) It's kind of like an open bank account secured against your house. The interest rate is lower than a credit card, but a little higher than a mortgage. You can transfer all the CC debt into it and pay it off as fast as you can pour money back into it. One of my friends who has a private practice with uneven income uses the HELOC to cushion against unexpected expenses or short months.
posted by seanmpuckett at 1:44 PM on November 10, 2020 [1 favorite]

Risking your home to pay down unsecured debt a bit faster seems unwise given that you are struggling financially. A lot of people do it, sure, but they're taking a massive risk with something that is (1) their biggest asset and (2) a necessity of life. It's not just a "go down to the bank and do it" kind of thing.

There's a reason the interest rate is lower and it's easier to get than a low-interest credit card: because the bank can take your home and sell it to get their money back.
posted by Rock 'em Sock 'em at 2:25 PM on November 10, 2020

If you're currently in a COVID forbearance, you may not be able to take additional mortgage debt in the form of a HELOC. I'm not sure specifically about HELOCs but many other mortgage types are requiring that you be out of forbearance and resume payments for a few months before taking a new loan.

You should probably also look into your post-forbearance options. Will your lender modify your payments to make up the deferred amount, or add them to the end of your scheduled loan term? Once you know what's going to happen there, you'll have a better sense of long term options.
posted by tinymojo at 2:49 PM on November 10, 2020 [1 favorite]

Most of the best 'get out of debt' writers suggest that you create a 'debt snowball'. You start by aggressively paying off the smallest credit card debt you have and making the minimum on the rest, and then once that's paid off, turning to the next smallest. It gives you a lot of psychological victories which is very helpful in maintaining your focus. This is particularly true if you overspent to create the original debt, as you're replacing one financial habit with another. It may not apply to you so well.

Long-term, if you are confident that you will pay down the debt and that you have addressed the reason that it arose (which) then it makes sense to convert it to a loan with a lower interest rate. That might be a loan from a credit union or bank, or possibly home equity or increasing your mortgage. If you're looking to put borrow more against your house, you need to be extremely confident that you can pay it back and that you have enough equity in your home that you're not at risk of owing more than the property is worth in the future (eg if house prices in your area fell by 20%).

If you're currently in forbearance then it's not the right time to put an additional charge on your home. You are already more at risk of losing it. If you're struggling to make payments in general, you might benefit from speaking to a debt adviser who should be able to look at your actual finances and make suggestions about consolidation or negotiation to lower your payment.
posted by plonkee at 12:48 AM on November 11, 2020 [1 favorite]

Depending on your credit/income/etc, consider a personal consolidation loan through someone like SoFi or Lightsource. I entered my 30s with more credit card debt than you have and made zero progress paying it down for years. I got a personal loan for 3 years at maybe 5% interest and was able to pay it off even faster than 3 years.
posted by tryniti at 10:59 AM on November 11, 2020

Just a note, but my loan officer told me that anyone who had accepted COVID-19 mortgage deferment would be ineligible for a refi for some time. You might ask a loan officer if it's even possible to get a refi before you make your plans around it.
posted by agentofselection at 8:31 AM on November 12, 2020

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