Tuesday, April 04, 2006
Whether to take out a home equity loan to pay off credit card debt
Personal finance advisors differ widely in their opinions about whether it's wise to take out a home equity loan to pay down credit card debt. What they recommend depends largely, I believe, on who they assume their audience is. If they assume that I'm someone who, after paying off my credit card debt, will turn around and max out my cards again so that I end up with both credit card debt AND a smaller safety net in my home, then they're going to advise me against it. Certainly, if I'm on the brink of bankruptcy, it would be self-destructive to convert credit card debt (which is dischargeable in bankruptcy) into secured debt against my house (which is not dischargeable).
On the other hand, if the financial expert I consult knows that I'm a highly disciplined individual with a history of a frugal lifestyle marred only by an unfortunate period of high debt due to illness, job loss, divorce, or business failure, then the advice I get might be very different. If I'm in no danger of having to file for bankruptcy, and I pay down my credit card debt with a home equity loan, and then cut up those cards so that I'll never use them again, then I'm actually in a much better position than I was in before I took out the loan. The interest on the loan is tax deductible, and the interest rate will be much lower than what I was paying on the credit cards.
When addressing a broad audience, finance experts can't give advice tailored to each individual's personality, so they have to choose whether to take the pessimistic view (which, unfortunately, is supported by statistics which show that people often do charge up their credit cards again after paying off that debt with a home equity loan) or the optimistic view (which is . . . well, optimistic).
So my advice is: "To thine own self be true." I've never settled on what this really means in the context of Hamlet, but what it means here is that if you can honestly and somewhat objectively assess which type of person you are in terms of debt, then you can make a sensible decision about whether to trade in some of your equity for a fresh start and a little peace of mind.
On the other hand, if the financial expert I consult knows that I'm a highly disciplined individual with a history of a frugal lifestyle marred only by an unfortunate period of high debt due to illness, job loss, divorce, or business failure, then the advice I get might be very different. If I'm in no danger of having to file for bankruptcy, and I pay down my credit card debt with a home equity loan, and then cut up those cards so that I'll never use them again, then I'm actually in a much better position than I was in before I took out the loan. The interest on the loan is tax deductible, and the interest rate will be much lower than what I was paying on the credit cards.
When addressing a broad audience, finance experts can't give advice tailored to each individual's personality, so they have to choose whether to take the pessimistic view (which, unfortunately, is supported by statistics which show that people often do charge up their credit cards again after paying off that debt with a home equity loan) or the optimistic view (which is . . . well, optimistic).
So my advice is: "To thine own self be true." I've never settled on what this really means in the context of Hamlet, but what it means here is that if you can honestly and somewhat objectively assess which type of person you are in terms of debt, then you can make a sensible decision about whether to trade in some of your equity for a fresh start and a little peace of mind.
