"Should I use a Home Equity Loan to pay off my debt?"

Question of the Week:

Should I use a Home Equity Loan to pay off my debt?

Here's a quick exercise in determining whether this move makes financial sense...

You'll need a sheet of paper (or two), a pen (or pencil), a calculator (if you don't have one, it's basic math anyway), and the invoices/stubs for your monthly bills (if you pay them online, log onto your bank's website and print your set of monthly bills and the payments due).

The Exercise:

• Go through each of your bills and write a list that includes the name of the card, the monthly payment due for each account along with the total balance due right next to it. You want to go down this list and tally the totals.
  

For example:
Macy's Credit Card                                          $45.50             $800
Bank of America Credit Card                         $145.45          $3,000
Best Buy Credit Card                                     $112.99          $2,500
American Express Credit Card                        $179.75          $7,000
Target Credit Card                                         $35                  $400
Banana Republic Credit Card                           $65                  $700
Credit Union Credit Card                               $185.00           $8,000
Medical Payments                                         $312.24          $14,500
       Total (Cash Outflow)                          $1,080.93         $36,900

• Assuming you have equity in your home (let's just say 20% for the sake of argument), you want to calculate the payment on a $36,900 Home Equity Loan or Home Equity Line of Credit. Now the current Prime Rate is 7.25% so you may very well derive a rate close to 7.25%. Your interest rate is determined by Credit Score, Doc Type (Stated Income or Full Doc), and Loan-to-Value. For the sake of argument, let's say that the rate you will derive is 8%. Let's calculate your new loan payment...

Loan Amount = $36,900

30-Year Fixed (Principal & Interest) at 8%
Payment = $270.76
Monthly Savings = $810.17

HELOC (adjustable rate) at 8%
Payment = $246
Monthly Savings = $834.93

Now if you compare your previous cash-outflow to your new mortgage payment, you can clearly see that it is much less than what you're currently spending on a monthly basis. The additional $800+ dollars in savings derived could be used towards more benefiting means like investing in yourself for retirement. If you want to take note of an additional benefit, the new interest on your Home Equity Loan is tax deductible unlike the interest on your credit cards.

So does it make sense to utilize a home equity loan to pay off your debt? Only if your new calculated payment is less than your current cash outflow and if you have equity in your home. My next piece of advice is that you exercise frugal spending habits. You don't want to refinance your credit card debts only to max them out again!

There's one additional thing that I want to reference here and I'm noting it because at least your getting a point of view directly from a consumer's perspective. JdRoth is author of Get Rich Slowly, a weblog that holds substantial readership and presence in the online community. He wrote a post titled:

Using A Home Equity Loan to Pay Off Credit Cards

After you read his post and engage in this exercise, you can determine whether it makes sense or not. You can contact me here if you have any questions.