'Good' Credit-Card Debt
Aleksandra Todorova
Jan 28, 2007
Turning home-equity debt into credit-card debt sounds like a dumb move.
"It's conventional wisdom that if you have credit-card debt, you want to consolidate it into a home-equity loan," says Gary Schatsky, a fee-only financial planner in New York. That's because home-equity debt has been cheaper and many Americans have used it, in part, to pay off credit-card bills.
But times are changing and sometimes ignoring that conventional wisdom can make sense. Rebecca Walker and her husband, of Broomfield, Colo., for instance, were anxious to refinance an adjustable-rate mortgage, but were told they had to pay off a $7,000 home-equity loan before that could happen. Transferring their home-equity balance to a credit card enabled them to refinance the mortgage -- and save money with a credit-card interest rate of 3.99% compared with the 6% on their home-equity loan.
While the average home-equity line of credit now stands at 8.7% and the average home-equity loan at 8.2%, according to HSH Associates, competition among the credit-card companies is providing some attractive rates on balance transfers -- some of which are valid for the life of the loan.
The result: If used under the right set of circumstances, Mr. Schatsky says, transferring home-equity debt to a credit card can save homeowners big money.
When the numbers are right -- meaning the interest rate is lower and you can afford the credit-card payments -- card debt is safer than owing money to your mortgage lender, says credit expert Gerri Detweiler. That's because, if you're delinquent, the lender can't move to foreclose on your home.
That said, such maneuvers aren't for everybody. Here's what you need to know.
- Higher Payments. Turning your home-equity loan or line of credit into credit-card debt will quickly backfire if you can't afford the new payments. And they will be higher. That's because home-equity loans or lines of credit are typically amortized over 10 or 15 years, while credit-card minimum payments use a shorter horizon, Mr. Schatsky says.
- Fixed Rate. If you're going to hand a big balance over to a credit-card company, it's best to do it with a balance-transfer offer that promises a fixed rate for the life of the balance. These offers range between 3.99% and 6.99% these days, with 4.99% being fairly common, according to Curtis Arnold, founder of the credit-card Web site CardRatings.com. Then, make sure the credit-card limit is high enough. Aim for at least twice the balance on your home loan, Ms. Detweiler says, to avoid high utilization reducing your credit score.
- Transfer Fees. When comparing different balance-transfer offers, don't forget the transfer fee, says Scott Bilker, publisher of DebtSmart.com. Fees have been on the rise and can go as high as 3% or 4% of the transferred balance, with no dollar cap. And when looking at your options, don't forget the tax break on your home-equity loan. If your loan rate is 6.5%, for example, and you're in the 25% tax bracket, you're essentially paying 5.04%.
- Pay on Time. After the loan is transferred, make timeliness your biggest virtue. Even one late payment may trigger a hike in the card's regular interest rate, or worse yet, its penalty rate. Your best bet: Set up an automatic payment schedule through your bank.
- Don't Use the Card. Assuming you are using a new credit card, put it in a drawer and forget about it as soon as the transfer is done. (If using an existing card, make sure any previous balance is paid off before transferring a new one.) If you use that card for purchases, those will start accruing interest at the regular rate. Banks apply all payments to the balance that carries the lower rate first. You may end up handing over whatever you saved on that transfer right back to the company that made it possible.
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