The U.S. economy is still getting a passing grade across most economic health signs – GDP growth, unemployment, and level of inflation are all at positive levels. However, that doesn’t tell the story of consumer debt.
A WalletHub study found that the average American had $8,284 in credit card debt, only $177 short of reaching an “unsustainable” level. But one could argue that the 15–25 percent monthly interest rates that unpaid credit balances carry make life plenty unsustainable for many households. Making progress on high-interest balances is easier said than done, especially with other debts like student loans and mortgages adding to the equation.
An estimated 80 percent of all Americans carry debt, but mortgages are by far the most common type. For households that have credit card debt, their mortgage—and specifically how much equity they have in it—could be the key to getting out of their crippling financial predicaments. Let’s discuss a few considerations.
A cash-out refinance is a worthwhile option for any homeowner to consider — not only ones in a lot of personal debt. Refinancing the terms of your mortgage might make sense if interest rates or conditions weren’t as favorable when you took the loan. In other cases, it could give homeowners needed cash to invest in home-improvement projects and increase its value.
For households with credit card debt, a cash-out refinance can also free up cash equity by replacing the existing mortgage with a new one. As Investopedia notes, how much cash you’re able to get with a cash-out refinance will depend on the loan-to-value ratio, which is comprised of the lender’s appraisal of the property’s current market value in relation to the balance left on a loan. In general, consumers can need to have at least 20 percent of their home’s equity to qualify for a cash-out refi. Costs range between two to four percent of a home’s value when accounting for everything from appraisal and attorney fees to inspection, title, recording expenses and more.
Home Equity Loan & Home Equity Line of Credit (HELOC)
Just as a borrower may consider a cash-out refinance for home-improvement liquidity and to align the terms of their loan with a favorable market, a household might seek a home equity loan or HELOC to make investments into their home. Remodeling a kitchen, finishing a basement or adding on to a home are all common ways of doing so, and these loans free up the capital to make it possible. However, these plans that add a second mortgage for borrowers to pay back can also be useful for getting out of debt.
The main differences between a home equity loan and a home equity line of credit are how the cash equity is dispersed and how interest is paid on the new loan. A home equity loan gives households a lump sum payment with a fixed interest rate. HELOCs, however, usually carry adjustable interest rates and allow households to draw money as needed. In fact, interest is only paid on the amount drawn. They essentially function like credit cards, albeit with much lower interest rates.
Either a home equity line of credit or HELOC can get households out of debt. Deciding between the two will depend on the amount of equity and whether a household wants the capital all at once with stable interest rates, or as they need but dealing with adjustable interest rates and varying payment amounts. Also keep in mind that home equity loans and HELOCs have closing costs, which end up being about 2–5 percent of the loan amount. How much you’re able to borrow via home equity loans or HELOCs will depend on the lender, but generally, home equity loans free up to 85 percent of a home’s value while HELOCs can generate as much as 95 percent.
Sell and Downsize Living Requirements
The increase in remote working jobs and trend toward minimalism makes it an ideal time to sell your house and downsize your living requirements. For many financial minds ranging from the impassioned Dave Ramsey to debt-relief entrepreneur Andrew Housser, taking a new loan against the place you live isn’t an option worth considering compared to refinancing or selling and downsizing.
While selling a home can be a long process, especially if you want to get anywhere close to your asking price, the amount you’re left with after you sell and pay off your mortgage is free money. Put it directly toward your debt and watch it disappear, saving yourself years of torment and thousands in interest long term.
Obviously, not everyone is in a position to make a move. But the current housing market is at a high point, and selling doesn’t add to or lengthen any loans in your life. All factors considered, selling is the safest and potentially most effective debt-relief strategy.
As you’re evaluating how much equity you have in your home and which of these plans you want to proceed with, make sure the math behind any decision works in your favor. If you’re merely moving money around and not making enough progress toward your other debt, you haven’t solved your problem. In fact, you’ll have only made it worse by dragging your home into the mix!