Dear Chuck,

I would like to eliminate our high interest credit card debt. What are your thoughts on taking out a HELOC to pay it off? 

HELOC or NOT?

Dear HELOC or NOT? 

Just to be sure readers know what we are talking about, HELOC stands for Home Equity Line of Credit. It is a line of credit that uses the equity in your home as collateral. Because of high interest rates and inflation, more and more homeowners are using a HELOC. The rates are usually more favorable than other forms of consumer debt, especially credit cards. This revolving line of credit is quickly replacing the older method of “cash out refinancing.” It can be helpful when used wisely because it gives homeowners access to equity to help meet cash flow needs—emphasis on the word wisely. 

General Thoughts on HELOCs  

Paying off credit card debt can be a good use of a HELOC for the disciplined spender. You must strive to reduce the use of credit cards and faithfully pay off the balance every month to avoid accumulating high cost debt again. Know, too, that if repayments of the loan are missed, you face the danger of foreclosure. So your decision must first be based upon your personal discipline to keep within a budget and a plan. 

A home equity loan pays a lump sum at a set interest rate, whereas a HELOC allows funds to be taken as needed. This keeps monthly payments lower and helps avoid unnecessary debt. Some nominal costs are involved, and interest is only charged on what is borrowed. However, the rate is typically variable, and the payout period ranges from 10 to 20 years. 

To qualify, verifiable income, good credit, and considerable equity are needed. Reliable payment history may be investigated. See Bankrate.com or Forbes for current HELOC rates. Lenders will use Loan-to-Value (LTV), Combined Loan-to-Value (CLTV), and Debt-to-Income (DTI) ratios as well as other factors to determine individual interest rates and the amount eligible to borrow. 

Terms to Know

• DTI: The percentage of monthly income that goes to repayment of other debts; monthly bills divided by total gross monthly income 
• LTV: Amount of loan divided by the value of the property
• CLTV: Total combined loans borrowed against the property divided by the total value of the property
• Draw Period: time during which money can be borrowed; interest only is required in payments 
• Repayment Period: time in which loan must be paid; additional funds cannot be borrowed unless the lender approves   

Pros

• Typically costs less than other forms of borrowing
• Interest is only charged when money is borrowed
• Interest on funds used to buy, build, or improve property can be tax deductible
• Flexible withdrawals for any purpose 
• Can be a method to boost credit history
• Can be easier to qualify for than other loans

Cons

• The home is used as collateral 
• Variable rates could increase payments
• Creates risk if the property’s market value drops
• Missed payments can lead to foreclosure 
• There are upfront and maintenance fees 
• Rates are higher than mortgage rates
• Increased debt can lower credit scores
• Total home equity drops until the balance is repaid 

When to Use

• Financing major home repairs or renovations that will increase home value
• To pay off or consolidate high interest debt (credit cards)
• Funding a necessity
• As a temporary bridge in the loss of a job
• When a borrower exercises self-discipline and will not simultaneously run-up credit card debt

When to Avoid

• Financing depreciating cars or consumer goods
• Purchasing frivolous items
• Covering the cost of vacations and entertainment
• Medical expenses that can be negotiated and paid without interest
• When a borrower struggles with overspending

HELOC or NOT? 

The best use of a HELOC is to increase property value. The risk is that one’s home is used as collateral. If convinced this kind of borrowing will be beneficial, compare rates and fees of different lenders. Understand the repayment structure and all requirements before signing any paperwork. What is the prepayment fee and policy? Does a low monthly rate come with a balloon payment? Will a shorter repayment timeline grant a lower rate? Is there an inactivity fee? Does your bank or credit union offer member discounts? 

Once the loan begins to amortize, monthly payments can be painful unless the borrower is disciplined and prepared. That is why I recommend that a payback plan be in place before borrowing any money. 

“The rich rules over the poor, and the borrower is the slave of the lender.” (Proverbs 22:7 ESV)

The Bible warns of debt becoming a form of slavery. Avoid presuming on the future—especially during uncertain economic times. And do not borrow to simply keep up with friends or neighbors. While a HELOC can be helpful in extreme cases, I always think it is best to make a plan to pay off the debt causing you pain without creating more debt. For most people, this is a safer and wiser path to financial freedom. 

My bottom line: paying off high debt with a low rate HELOC can be wise if the Lord directs you in this way. Pray for wisdom. 

Christian Credit Counselors is a trusted source of support in assisting people with getting on the road to financial freedom. Reach out to them today; they may be of great benefit to you.

This article was originally published on The Christian Post on April 28, 2023.