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Apr 16 2012 12:00AM

Question

We had several lean years during which we accrued significant credit card and other debt. We are now moving in the right income direction but I am concerned about how to use our increased pay most efficiently in paying off debt. Does it make sense to use a home equity loan to pay off high-interest credit card debt in order to raise our credit rating and save money over the long-term?

Answer

If you use a home equity line of credit to pay off credit cards, then you put your home more at risk. By that I mean a credit card is an unsecured loan whereas a home equity line of credit is a secured loan, it is secured by your property, your home.  So if you default on a credit card, it only hurts your credit rating and it is very difficult for them to make you pay back the money. They will try, but it is not secured by anything tangible that they can take from you.  In contrast, if you default on your home equity line of credit the lender has recourse to seize your home.  

If you do pay off your credit card debt with a home equity line of credit, you will most likely pay less in interest. The interest charge on credit cards is usually significantly higher than a home equity line of credit which might be around prime or prime +1 which is 3.25 to 4.25%.

As to which will help you increase your credit rating, I do not have an answer for that.  The timely payment of credit cards is an important aspect to your credit rating. In the timely payment of your mortgage debt or home equity debt is also an important aspect to your credit rating.  I don't know which they rank higher in their credit rating algorithm.

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