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Home Equity Loan To Pay Off Debt?

November 24th, 2008 at 05:49 am

One of the most common questions I am asked is:

"Should I get a home equity loan to pay off all of my non-house debt?"

Here is my response.

I am not a big fan of consolidating one's non-house debt into a home equity loan. This is for several reasons, and I have outlined those reasons below.

* This is addressing a symptom, not the root cause. This question is usually motivated by our need for immediate action. It is the same motivation that causes us to purchase a car and finance it for five years.
* Borrowing from home equity makes it more difficult to sell the house. This is especially true in today's house market. There are a ton of people who now owe more on their house than it can be sold for. Consequently, they become trapped in the house.
* Changing spending behavior is a process. If one runs out and consolidates their debts, it might remove the urgency from the need to change spending behavior. Changing one's spending behavior takes time. I am convinced that if I had obtained a home equity debt consolidation loan in December 2002, I would not have changed my spending behavior. However, because it took fourteen months to address our debt, our spending behavior was completely changed. We have never looked back!

Having spoken with thousands of people and working one-on-one with nearly one thousand people in the past two years, I am convinced that obtaining a home equity loan is not the best way to eliminate debt. The most common result from obtaining a home equity loan is less equity in the house and the consumer debt shows back up because the spending behavior was not changed.

This is, in fact, my own story. I obtained a debt consolidation loan to move a pile of credit card and consumer debt to one payment. After paying $315.60 a month for an eternity, I wanted to celebrate, but I could not. Why? Because while I had finally paid off the debt consolidation loan, I had not changed my spending behavior and my credit card debt had grown back to more than I had consolidated in the first place!

What do you think?

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4 Responses to “Home Equity Loan To Pay Off Debt?”

  1. disneysteve Says:

    I think it depends on the situation. It is true that many people take out a debt consolidation loan only to turn around and rack up new debt. That's bad.

    However, there are responsible folks out there who take out home equity loans for the right reasons - to decrease the interest rate and reduce the overall cost of borrowing. For example, perhaps you had an unexpected medical bill and had to put it on the credit card at 18%. You can move it to a home equity loan with an after-tax rate of 5%. Assuming all of your other financial ducks are in a row, that could save you a bunch of money in interest.

  2. Ms. Pearl Says:

    I agree with you. When you take out an equity loan to pay credit cards that have gotten out of control you are not addressing the root cause. Yes, it may be a lower interest rate but at what cost? Plus, many many people just go and charge up their credit cards again. I am sure there are responsible people out there who do not do this but they are the exception.

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