Joshua Bacchus, CPA, CFP®, CLU®
Financial Advisor
Financial Advisor
Article Licenses: CA, DL, unknown, unknown, unknown
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Consumers are shifting unsecured high-interest credit card balances and debts such as car loan balances to a low-interest Home Equity Line of Credit (HELOC). This transference happens on a larger scale when people consolidate their debts while backing them with their home value. Once your home secures this debt, it is no longer unsecured debt in your portfolio.1
You may indeed be able to save a sizeable chunk of interest by transferring debt from a high-interest credit card to a low-interest HELOC. For many, this works well insofar as they have an intelligent debt repayment plan in place.
When developing a financial strategy, assess all of your credit cards and other loans, including a Home Equity Line of Credit (HELOC). Total your combined debt while you weigh this against all of your retirement and your non-retirement assets.
A safety precaution always estimates your decisions about how they will impact your net worth statement when subtracting liabilities from assets. Adding in your HELOC debt with your portfolio of obligations gives you proportional insight into your actual net worth. Add your HELOC level of debt alongside your unsecured credit cards. Compare interest rates, fees, and other features and the time it will take to pay these loans all off (some calculators do a great job comparing this).
That said, be cautious using HELOC debt as quick loans for vacations, 2nd residences, extensive renovations versus selling and repurchasing a new home, vehicles, businesses, or investments. HELOC credit cards offered with most lines of credit will also reduce your home equity value.2
This growing shift of unsecured credit card debt to HELOC debt enticed by lower interest rates (related to your mortgage) helps the lenders’ balance sheets because this debt, once transferred, becomes secured collateral against real estate assets then owned at a higher proportion by the bank. Taken to the limit, if the real estate market prices drop, your debt may surpass your home value — this happened in the 2007-8 mortgage debt crisis. Think seriously about reducing your debt portfolio, especially if you hold a lot of HELOC debt.
Many people are inadvertently reducing their home equity in the process of securing previously unsecured credit card debt while hinging it to and reducing their home value. When people sell their homes, they are often surprised that their home equity is considerably reduced after paying their mortgage. Why is this? You must pay all associated HELOC debt during the sale.
Source: Bank of Canada
1 Most credit cards are unsecured by any asset that you own. However, if you accept a credit card linked to your home which offers low interest, this may be secured against your home value. Many consumers are unaware of how this works.
2 If bankruptcy occurs, your home equity generally is safe unless it is secured against HELOC debt. Unsecured credit cards are often simply not necessary to repay should one seek bankruptcy protection. Always read your small print in all contracts. Don’t rely on sales discussions over the phone or in-person until you read the small print. It is only beneficial to a bank or financial institution to shift your debt from unsecured credit card debt to secured debt if bankruptcy ever does occur.
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