Credit card debt could be compromising the financial security and well-being of millions of individuals. According to the Federal Reserve Bank of New York, Americans’ total credit card balance in the second quarter of 2023 was more than $1 trillion, and LendingTree reports that the average credit card balances among U.S. cardholders in December 2022 was $7,279. Average balances are lower but still a concern in Canada, where data from TransUnion® indicates the average cardholder had an outstanding balance of $3,909 as of the first quarter of 2023.
Effective credit utilization is a vital component of long-term financial health. The average credit card balances in both the U.S. and Canada suggest many consumers are putting their financial futures in jeopardy by relying too heavily on credit to fund their lifestyles. The good news is consumers tend to have a sense of self-awareness regarding their credit usage, as a recent NerdWallet survey of more than 2,000 adult consumers found that 83 percent of respondents acknowledged they overspend. Recognition of an over-reliance on credit could be a solid first step toward eradicating debt, and consumers who own their homes may consider home equity loans or lines of credit in an effort to tame their debt once and for all.
What is a home equity loan?
The Consumer Financial Protection Bureau notes that a home equity loan allows homeowners to borrow money using the equity in their home as collateral. Equity is the amount a property is currently worth minus the amount currently owed on a mortgage. So if a home is worth $500,000 and homeowners have a mortgage balance of $300,000, then their equity is $200,000.
Why do homeowners consider home equity loans to pay off debt?
One of the biggest concerns when consumers wrack up lots of credit card debt is the likelihood that they will end up paying substantial amounts of interest on that debt. That’s because credit cards typically have high interest rates. Indeed, the LendingTree reports that even consumers with good credit may have an APR around 21 percent on their credit cards. That figure only grows for consumers with lower credit scores. Bankrate notes that the average interest rate for a home equity loan is typically much lower than the rate on credit cards, so homeowners can theoretically save a lot of money by paying off their credit card debt with a home equity loan.
Are there risks associated with using home equity to pay off credit card debt?
Though lower interest rates and consolidated debt are two advantages to paying off consumer debt with a home equity loan, this option is risky. Perhaps the biggest risk associated with this approach is the potential of losing a home. Individuals with substantial credit card debt should know that a lack of discipline when using a home equity loan to pay off debt could result in foreclosure. If homeowners cannot make their monthly loan payments on time, they could lose their home. In addition, Bankrate notes that if a home is sold with an outstanding home equity loan balance, that balance must be repaid at once.
Home equity loans can help homeowners consolidate and ultimately eliminate their credit card debt. However, this approach carries a level of risk, so homeowners may benefit from working with a financial advisor to determine the best way to pay off their existing debts.