Debt Consolidation may be a better alternative

Have you seen those bank and mortgage ads on TV and newspapers telling you to pay off those pesky high interest credit card bills by tapping into the equity of your home? They make it sound real simple, apply on-line, call-us toll free, answers within hours, etc. They almost sound too good to be true. We all know about the dangers of things that are too good to be true. So, what are the dangers of using your equity to pay off your credit card debt? A minor detail they forget to mention in those ads; while banks frequently advertise home equity loans as a way to consolidate other high-interest debt, these loans don't wipe the slate clean. You still owe the money, and now it's linked to your homeownership. Before we start, let's understand some important financial terms: Unsecured debt is not guaranteed by the pledge of collateral. Most credit cards are an example of unsecured debt, which is why their interest rates are higher than other forms of lending, such as mortgages, which employ property as collateral.

Secured debt is secured by a lien on debtor's property which may be taken by the creditor in case of nonpayment by the debtor. A common example is a mortgage loan.

Equity is how much of the house you actually own. In other words, it is the price of your house on today's market minus the amount of any loans secured on the property. For example, if your house is worth $170,000 and your mortgage balance is $115,000, then your equity is the difference -- $55,000. This value can go up or down depending on economic conditions.

You can't sell that portion of the house that you own outright. It's a package deal with the part that you're still paying on. However, you can get a hold of some of that money through a home equity loan(also known as a second mortgage).

Lately, many of us have experienced an increase in the equity of our homes or condos because of an unprecedented increase in our home values. This is mostly fueled by the abnormally low interest rates. These low interest rates created a home buying frenzy since the monthly cost of ownership was so cheap. For the past year though, interest rates have been steadily climbing and the monthly cost of home ownership has been steadily increasing making it more difficult to purchase a home. This has resulted in a glut of homes on the market for sale. Remember the old supply and demand theory? More supply than demand for homes means the price of homes will fall and so will the amount of equity in the home.

Using our initial example, if you went to the bank and took a home equity loan for the $55,000 to pay off your credit cards, you have now secured all of this (unsecured) debt to your home. Taking this one step further, as interest rates go up, your home could go down. So, in theory you could owe more than the actual value of your home. This means if you wanted to sell your home and it was now worth $150,000 you would have to come up with an extra $20,000 just to be able to satisfy your financial obligation. In 1988, homes throughout the country were at their highest value. Then in 1989, due to economic conditions, many companies had laid off employees and the housing bubble burst causing homes in some parts of the country a loss of up to 50 percent of their value overnight! There is no reason why this could not happen again. This is not a healthy scenario.

The good news about equity loans is that they have lower interest rates than credit cards because they are secured against your house. The bad news is these loans are secured against your house. If you miss a payment then you risk losing your home. Miss a credit card payment by itself and initially you will only have to listen to debt collectors, but you will still have your home.

The disadvantages of using a home equity loan to pay off your credit cards:

* By pulling money (equity) out of your home to feed your spending habits, you may end up homeless.

* If you use your home to pay off credit card debt you lose your safety net.

* Taking out more debt to pay off current debt is a loser's game. Please note: If you borrow more than 100 percent of the value of your home, or if the home equity loan is more than $100,000.00, some of the interest will not be deductible.

According to Bankrate.com, the worst possible long-term cost of a home equity loan is foreclosure. If you cannot afford two mortgages on your house, especially if other debts pile up again, you can lose your home to the bank. Defaulting on only one of the mortgages can lead to this expensive conclusion.

Contact a reputable Debt Consolidation Company

There is little or no cost for the services. Most of the agencies are called Debt Management Credit Counseling Service and they:

* Work with lenders to negotiate a repayment schedule you can afford -- including making efforts to get finance charges reduced or waived.

* Develop a payment plan you can afford.

* Help you re-establish credit when your current debts are paid off.

If you participate in a Debt Management Program (DMP) program, it will show up on your credit report. However, your credit is already blemished, your financial life is a mess, and you need to take drastic measures to get back on track. Since the bankruptcy laws have recently changed, the bankruptcy option may no longer be an option.



About the author:

Pete Glocker is employed in the Education and Charitable Services Department at Debt Management Credit Counseling Corp. ("DMCC"), a 501c(3) non-profit charitable organization located in Boca Raton, Florida. DMCC financial counselors can be reached for free education materials, budget counseling and debt management plan quotes by calling 800-863-9011 or by visiting www.dmcccorp.org. Pete Glocker can be reached by email at p