Q. My husband wants to take out an equity loan to pay off our car and credit cards. I don't think it's a good idea. What do you think?
A. An equity loan can be good only if old spending habits are changed and your monthly payment is lowered.
By using the equity in your home to pay off your car, the money you save is only temporary. Most people will eventually need a new car that they'll be required to make monthly payments on. How often do you replace your car? Do you really want to finance your car for 15-30 years with an equity loan?
The same is true with paying off your credit cards. If you don't change your spending habits with credit card spending, you'll defeat the purpose and run up new debt.
Both you and your husband need to make a list of all the items you want to pay off. Determine if these debts will be paid off within two to three years. If so, don't do anything.
The problem with an equity line of credit loan is that it can be used like a credit card. Temptation is always there to make purchases that may not be necessary. That reduces the equity in your home.
Plus, because it's viewed like a credit card with a maximum limit, your fico credit score can be lowered. If an equity line balance is too high to the credit limit (more than 35 percent), your score may be lowered. For example, if you had a credit limit of $100,000 and a balance of $80,000, the score would be lowered. To not be affected, you'd need to keep the balance below $35,000.
In most instances, the equity line of credit doesn't have a fixed interest rate. They're adjustable interest rates, so the payment may increase each month. Also, most equity lines of credit are interest-only loans that add nothing to the principal. The interest rates are usually higher than a first mortgage. Some lenders will fix a portion of the balance with a fixed interest rate.1