How soon we forget. Just yesterday I was flipping through a magazine and I saw an ad by a credit union that was offering to help you pay off your credit card debt with a Home Equity Line of Credit (HELOC). Here in Arizona we are just starting to climb out of the huge economic mess that was the last five years, but there it was, someone wanting you to pay off credit cards by taking out a loan on your house.
I guess it is a good sign that banks are thinking that people actually have equity in their house (as opposed to being upside down). But still, wasn’t this what got us all in this mess in the first place?
Asking people to take a loan out on their house to pay off credit card debt implies that it is better to have secured debt, like a mortgage, than it is to have unsecured debt, like a credit card.
While the correct answer is to have no debt at all, before you even think about taking a loan out on your home to pay off debt it is important to understand the difference between secured debt and unsecured debt.
Secured debts are those to which there is some sort of collateral or property attached to. The most common secured debts are home mortgages and car loans. But any loan with property attached – boats, RVs, motorcycles, etc. will be considered secured.
When it comes to secured debts if you don’t make the required payment the party who is secured – usually a bank – can take back the property that is securing the loan. So, if you don’t make your house payment you get foreclosed. If you don’t make the car payment it gets repossessed.
Debts or loans where there is not property attached are considered “unsecured”. The most common unsecured debts are credit card, medical, personal loans.
If you don’t pay on an unsecured loan the creditor can call you and ask you for payment, but if you don’t pay them they can’t take anything from you.
Sometimes, a debt that was unsecured can be transformed to a secured debt. For example, the typical credit card debt is unsecured. However, if you don’t pay that debt the credit card company has the right to sue you for the amount owed. If they get a judgment against you then, in Arizona, they can take that judgment down to the country recorder’s office and file it. At that point that judgment acts as a lien against any real estate you happen to have in that county.
Likewise, an unsecured tax debt can turn into a secured debt if the IRS files a tax lien against you. Once an unsecured debt is changed into a secured debt, the creditor can start taking things from you.
So, back to my original thought – is it a good idea to pay off credit card debt with a home equity line of credit? I would say no. It is not. Because you are taking an unsecured debt and voluntarily turning into a secured debt – which means that you can now lose property if you run into a tough time and can’t pay.
Before you take out that HELOC, you ought to evaluate what will happen if things go bad. If it is a credit card debt you may get some phone calls and may get sued. If that credit card debt is now a HELOC you could end up losing your home.