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Debt Cleanup: Balance Transfers and Home Equity Loans

By sbup Staff
If you’re carrying a pile of debt at high interest rates, consolidating is one way to save money and get out of debt sooner. Two of the most popular ways to consolidate debt are with credit card balance transfers and home equity loans. Both have their share of advantages and disadvantages.

If you’re thinking of consolidating your debt, use sbup’s Loan Consolidation calculator to help you do the math on your options. Here's a quick roundup of the pros and cons of each tactic.

Credit Card Balance Transfers
Transferring balances from high-interest credit cards to a lower-interest credit card can save hundreds of dollars a month on finance charges without much effort. For those with the best credit scores, credit card offers for 0% interest on balance transfers are available. Credit card companies like Discover (Stock Quote: DFS) and Citibank (Stock Quote: C) typically dangle 0% offers as incentives for new customers.  The lower interest translates into lower monthly payments. If that savings is reapplied to paying down the debt, it can be settled that much faster. Use sbup’s accelerated debt payoff calculator to see how much faster for yourself.

Those carrying high credit card balances often have low credit scores and cannot qualify for the best rates on balance transfers. Additionally, even the best rates are often only for a short introductory period, after which they can jump. Missing a payment can also trigger a “universal default” at which point the APR on the card can skyrocket. Some credit card companies also charge high balance transfer fees that can equal up to 4% of the amount transferred. Finally, frequently opening up new cards to make balance transfers can negatively impact your credit rating.

Home Equity Loans
Those carrying considerable debt may have difficulty using balance transfers to consolidate it all. New credit cards may not have a high enough limit. In these cases, a home equity loan may be a more practical option. Of course, you have to have enough equity in your home to cover the outstanding balances. One added benefit to using a home equity loan instead of a balance transfer is that payments are often tax deductible. That can translate into thousands of dollars of savings depending on the size of the loan and your tax bracket.

With home prices falling and lending standards tightening, it can be difficult to obtain a home equity loan. Additionally, many lenders now require 10-20% of equity to remain in a property after the loan. Borrowers now need to have much more equity to qualify for home equity loans of the same size. While the average home equity loan carries a lower interest rate than the average credit card, these rates are far higher than advertised balance transfer rates. Finally, the largest disadvantage of choosing a home equity loan is that your home is used as collateral. If you default on a home equity loan, you could lose your home. If you default on your credit card the most you lose is your credit reputation.

Regardless of which option you choose (if either), it’s important to recognize that you cannot borrow your way out of debt. If you choose to consolidate your debts, do so with a plan for how to reduce credit consumption in the future.

For more on debt consolidation:
“When Does Consolidating Debt Make Sense?”

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