Borrowing on your home to pay credit card debt

There has been a rash of refinancing during the past few years (since Texas laws changed to allow homeowners to borrow on their home equity). Many people have pulled money out of their homes to pay off high-interest credit card debt. People have asked me if that's a wise decision. My answer has always been NO. Here are my reasons.

The first and most important reason is that the homeowner is trading unsecured debt for secured debt. This is a practical consideration. In case of a Chapter 7 bankruptcy (the debtor throws in the towel and wipes out all debt) unsecured debt in Texas basically goes away (I'm not a lawyer, this is not legal advice, but I've worked with many, many people in trouble and this is the general rule in our state). Secured debt remains attached to the asset; in this case the house. So let's say a couple owe $100,000 on their home, and they owe $50,000 in credit card debt. If they borrow the $50,000 on their home equity, they'll probably increase their home debt (secured debt) to $160,000 after the refinancing fees. Much of their home equity has disapeared; bad for the homeowner. Unsecured debt has disappeared; good for the banks.

Now let's say this couple gets in financial trouble (yes, we know it won't happen to you or me...but then, you never know). If there had not been a refinance, and the couple wants a chance to start over by using the Federal Bankruptcy statutes, they get to keep their house and its affordable payments; the choking unsecured debt goes away. "No way!" Some people scream, "That would ruin my credit." Ruin, no; set them back for a couple of years, yes. But if one of them has been laid off, there simply won't be any money left over to cover all monthly payments.

If there has been a refinance the typical scenario is that the couple lose their home. The house no longer has a comfortable payment; it might be too high for the owners to handle. Back to apartment living; wait a few years till the credit gets better; start all over again.

Here's another reason I give it a big NO. That same couple might be in their mid fifties. There might be 13 years left to pay on the loan. A refinance is usually done using a 30 year loan. Now instead of paying off their home in their sixties, they'll be paying on it till they're in their eighties; not a pleasant way to spend their retirement years.

Oh golly, there are so many other reasons...but those above are enough because they're such strong reasons NOT to pull equity out of a home to pay unsecured debt.