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Carrying a lot of credit card debt can be a stressful, miserable experience. Having to juggle multiple payments per month, deal with creditors, and manage cash flow is difficult when there is barely enough income to make ends meet. Many consumers find that they fall further and further behind each month as they continue to utilize credit cards to bridge the gap when they are short on cash. If this describes your life, you are not alone.
As of today, millions of Americans are carrying very high levels of credit card and other consumer debt. In fact, the numbers show that household debt has recently reached an all-time high. According to this article in the New York Times, household debt has recently surpassed the previous high reached during the financial crisis of 2008. Consumers were a whopping $12.73 trillion in debt at the end of the first quarter of 2017.
The economy is finally showing signs of life after many years of stagnation and little to no growth. Now, lenders are easing their credit practices and, overall, consumer credit is on the mend. Because of this, rising consumer debt shows no sign of slowing down. However, because the economy is beginning to expand again, the new high in household debt levels is not as big of a concern as it was in 2008. In an expanding economy, consumers generally have more financial resources and disposable income, thus should be able to manage their debt more effectively.
However, one of the largest increases in consumer debt has been in the student loan sector. This is a concern for the economy. Rising debt among young people can have a chilling effect on the growth of the economy, as it may represent a roadblock to other large purchases such as homes and automobiles. Student loans can also carry high interest rates and longer terms, making them difficult for young people to pay off, especially if the job market is sluggish.
According to the same New York Times article, student loan in America totals $1.3 trillion, more than the twice the amount Americans were carrying to 2008 in the midst of the financial meltdown. Student loans also carry the highest delinquency rate of any consumer loan, according to the New York Fed's quarterly report. Without some way to mitigate this high debt, students face a handcuffed future that leaves them unable to bolster the economy with big-ticket purchases.
Auto loans have also been a fast growing debt sector in the last few years and represented 9% of all household debt at the end of the first quarter of 2017. This is 3 percentage points higher than it was at the peak of the financial crisis in 2008. In addition, defaults on auto loans have also risen in the past nine years. This is because the auto sector was one of the few sectors in which banks and other lenders were willing to continue lending to subprime borrowers.
While credit card debt is a smaller percentage of overall household debt, for the individual consumer, it represents a significant amount of debt. For those households that hold credit card debt (not all American households do), the number breaks down to $16,040 per household, according to The Motley Fool. That is a staggering amount of debt for any consumer to manage, especially since it is usually at an interest rate of 10% or more.
What causes Americans to fall into debt?
Americans take on debt for a number of reasons. Some of the reasons are to address life's necessities that consumers cannot afford to pay for in cash. A mortgage is, most likely, the largest loan that most consumers will ever acquire. Homeownership is part of the American dream and, traditionally, has been a good path to building wealth. Most Americans aspire to own their home as soon as they can afford it.
When the housing bubble burst during the Great Recession, many lost all of their accumulated housing wealth, some to the point of owning homes that were worth way less than what they owed on them. This was catastrophic to the U.S. economy, as many homeowners lost their homes to foreclosure or had to liquidate them through short sales. As the housing market has stabilized, Americans who have been able to clean up their credit are jumping back into the housing market with gusto.
Automobiles are another of life's necessities and one that most people need to take out a loan to purchase. Buying a car is, most likely, the second largest purchase consumers will ever make. However, while the purchase of vehicles in America continues to climb, so do the delinquencies, as lenders continue to make auto credit available to subprime buyers.
Student loans represent another of life's necessities. The rapid rise in college tuition over the past few years has made it difficult to complete an education without some kind of financial assistance. Behind mortgages, student loans represent the second largest category of household debt.
Debt accumulated outside of financing life's essential purchases comes in many shapes and forms. Sometimes, consumers accumulate debt due to circumstances beyond their control, such as the loss of a job. Losing a job can be one of the most stressful and financially devastating events a person can go through. Job loss can cause anxiety and loss of self-esteem, all while wreaking havoc on a person's finances. If the person is unable to find a suitable, equally paying job to replace the one lost, he or she may start to pile up substantial amounts of debt in a very short period through credit cards and loans.
Unexpected illnesses and injuries can sometimes throw a family's finances into chaos. Aside from the medical bills, loss of income from being out of work can make matters critical very quickly. Often times, safety nets such as short-term disability are insufficient to cover even everyday expenses, and they take a bit of time to kick in. During this critical period, expenses and credit card debt can accumulate very quickly. Medical co-pays, prescriptions, and deductibles can add up to large amounts of money, even with the best of insurance.
Many times, consumers fall into debt unintentionally through a basic lack of knowledge about how to manage their money and make financial decisions. Lack of budgeting skills and the inability to save money can leave some consumers vulnerable to cash flow shortages. This can force them to rely on credit cards and other forms of consumer credit. Some consumers do not know how to control their spending or live within their means, and many do not have experience in stretching their dollars to make ends meet. When this happens, many consumers need to look for alternatives, such as debt consolidation, to address their debt and get their finances under control.
Using your home equity to consolidate your debt
If a consumer is struggling with a significant amount of debt, he or she may consider using home equity to consolidate it and pay it off. There are some advantages and disadvantages that every consumer considering either a home equity line of credit (HELOC) or a home refinance with cash out should consider.
A home equity line of credit is a loan that lets a consumer tap into the equity in his or her home on an as needed basis. Typically, borrowers receive approval up to a certain amount, and they can draw down the funds whenever they like for whatever purposes they choose. The payments are based on how much you borrow as well as the interest rate and the terms of the loan. Some home equity lines of credit are "interest only" for a period, meaning the consumer only pays interest on the amount drawn. Eventually, most home equity lines of credit revert to a more conventional type of loan with a set payback schedule.
A home refinance cash-out is a mortgage loan that refinances the existing first mortgage but allows the borrower to borrow additional funds. These funds are usable for any purpose the borrower chooses. Home refinance with cash out has a set payment schedule for the life of the loan, usually 30 years.
Advantages of home equity loans
Lower payment and interest rate
One of the biggest advantages of using your home equity to consolidate and pay off other debt is the ability to get a much lower interest rate than what credit card companies usually charge. This means the borrower will have a payment that is usually far less than the combination of payments he or she is already making to creditors. This can add significant cash flow to a consumer's monthly budget and take the pressure off if he or she is struggling with finances.
Easy to qualify
Home equity lines of credit are, usually, easy to qualify for if a consumer has sufficient home equity and a decent credit score. Closing costs are minimal, making them more economical than a home refinance with cash out that may require more processing, underwriting, and prepaid funds.
Disadvantages of home equity loans
You could potentially put your home at risk: When you utilize your home's equity to consolidate your debt, you move that debt from an unsecured position, meaning there is no collateral up against the debt, to a position secured by your home. This can be risky if, for some reason, your circumstances change and you can no longer afford the higher mortgage payment. Losing your home to a foreclosure is a financial catastrophe, something every homeowner should guard against.
Longer loan term could mean paying more in interest
Mortgage loans, either home equity lines of credit or a home refinance with cash out, usually have very long loan terms. Most mortgages are amortized over a 30-year period, which is a long time to be paying off credit card debt and other consumer debt. Consumers should think about this when considering using the equity in their home to pay off debt. With such long loan terms, it is likely that consumers will pay far more interest on those debts than they would if they just set a payment plan to pay them off and stuck to it.
The risk of running up debt again if spending habits don't change
Paying off credit card debt with the equity in a home may solve the problem in the short term, but if the consumer doesn't change spending habits or lifestyle, he or she could quickly run up credit card debt once again. Those who do the hard work of buckling down and paying off their credit card debt by reducing expenses, budgeting, and discipline are less likely to fall into heavy credit card debt again. Learning to budget money, make ends meet, and create savings are skills that every consumer should learn, even if done the hard way.
Don't wait, start today
Consumers who are carrying a heavy burden of credit card debt need to get started on figuring out a way to mitigate the debt and get their finances under control. If they wait too long, they may find their options have become extremely limited. If they are unable to find a bank that will lend them a portion of the equity in their home and are unable to obtain a personal loan to consolidate their debt, they may want to consider working with a debt relief company.
Companies such as National Debt Relief work with consumers to help them reach a settlement with each creditor until all of their debts are resolved. While it is not an easy process and it takes some time, for some consumers, it is the only way to get out from under debt short of filing for bankruptcy. Filing for bankruptcy is a financial decision that will stay with a consumer for many years, and it will severely affect their ability to get credit in the future.
Explore your options today and take the necessary steps to secure your financial future.