When times are tough financially, it might be tempting to find relief from your monthly bills by consolidating your credit card debt. One way to achieve debt consolidation is to borrow against your home equity to pay off those pesky cards. Here are two reasons, one strategic and the other behavioral, why I encourage you not to go that route.
Reason 1: A bad debt pay-off strategy
There’s a difference between secured and unsecured debt. If you have a mortgage or home equity line of credit, those debts are secured. That means your house is collateral for the loan, and the lender can take your house away if you don’t make your payments. Likewise, car loans are secured debt. In that case, your car is the collateral on the debt, and if you don’t make your payments, the lender can repossess your car.
Credit card debt, on the other hand, is unsecured debt. The lender has issued you credit based on your credit history. If you fail to make your payments, they cannot repossess your vehicle or your house. They can send you to a collection agency, however. If your situation is beyond help and you file bankruptcy, the court proceedings can discharge your credit card balances, but you won’t necessarily lose your house.
Borrowing against the equity in your home to pay off (consolidate) your credit card debt effectively changes your unsecured debt into secured debt. It can feel like a winning move to do this sort of consolidation, though, so be sure to pay attention. Consolidating credit card debt with a loan against your house will likely significantly lower your total monthly payments.
That’s good, right? No, it’s not. The reason your payments drop is that you are stretching out the pay-off horizon significantly. Most people use a 30-year mortgage. Think about that. Do you really want to be paying for the items you bought on your credit card for the next 30 years???
Reason 2: It doesn’t fix the underlying behavior
Sometimes people suffer an unexpected economic downturn and turn to using credit cards to get through the rough patch. When times are better, they pay off the cards and continue on a good financial path.
More often, however, people use credit cards because they are living beyond their means. There are a million reasons (excuses) that they might use for WHY they do it. Reasons like:
But I worked so hard, I DESERVE to treat myself (even though I really can’t afford it right now)!
Ok, I’m short on funds right now, but NEXT month, I’ll get on track (repeat pattern each month).
I need to keep up appearances now. I’ll pay this off when I’m earning more money.
It doesn’t really matter WHY you do it, what matters is THAT you do it. And in most cases, you will continue to do it, considering how easy it was the first time. Thus, you develop a pattern of living beyond your means by using credit cards to purchase things you cannot afford on your current income.
It would seem like a good solution to just consolidate all that credit card debt away: then you wouldn’t have that nagging debt balance hanging over your head, right? Wrong. In most cases, people who wipe out their credit card debt through debt consolidation using their home equity will go right back to racking up additional debt on those sparkly-clean cards.
Why? Because they didn’t address the underlying behavior of why they had that debt in the first place: living beyond their means.
What to do instead of debt consolidation
Resist the urge to use a mortgage refinance or a home equity loan to consolidate your credit card debt. Instead, immediately stop further use of the cards and use the snowball debt pay-off technique to tackle those card balances. The only way to truly get out of credit card debt is to change your spending behavior once and for all. Otherwise, you will just be applying a Band-Aid to the problem.
Accept that it will require great discipline to stick to a pay-off plan that might take many months or even years to accomplish. You can do it! Have faith in yourself.
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