Should I Use a Line of Credit to Pay Off Credit Cards?

Credit card debt can feel overwhelming, leading many individuals to seek solutions that promise financial relief. One option often considered is using a line of credit to consolidate and pay off existing credit card balances. This article explores whether leveraging a line of credit is a suitable strategy for managing credit card debt, guiding readers through the considerations necessary to make an informed financial decision.

Understanding Lines of Credit

A line of credit (LOC) provides flexible access to funds up to a predetermined limit. Unlike a traditional loan that disburses a lump sum, a LOC allows you to borrow, repay, and re-borrow funds as needed, with interest typically accruing only on the amount utilized.

Consumers commonly encounter two main types of lines of credit: personal lines of credit and Home Equity Lines of Credit (HELOCs). A personal line of credit is generally unsecured, with borrowing limits typically based on an individual’s creditworthiness and income. In contrast, a HELOC is secured by the equity in your home, providing a potentially larger credit limit and often a lower interest rate. Interest on a line of credit is usually variable, tied to a benchmark rate, and calculated daily on the outstanding balance.

Comparing Line of Credit to Credit Card Debt

Credit cards often carry high average annual percentage rates (APRs), with typical rates ranging from approximately 21.95% to 24.35%. Personal lines of credit, while variable, generally offer lower starting interest rates, often beginning around 9.75% to 11.50% APR, though they can extend higher depending on creditworthiness. HELOCs tend to have even lower rates, averaging around 8.12% APR.

Credit card debt is unsecured, while a HELOC is secured by your home. This collateral requirement for HELOCs contributes to their lower interest rates, but it also introduces the risk of losing your home if you default. Both credit cards and lines of credit are revolving, offering flexible access to funds, but credit cards typically provide a grace period on purchases before interest accrues, a feature not common with lines of credit where interest usually begins immediately upon drawing funds.

Factors to Consider Before Using a Line of Credit

Comparing the interest rate offered on the line of credit to your current credit card rates is an initial step. A personal line of credit’s rate might start lower, around 9.75% to 11.50%, but it is often variable and can fluctuate, while credit card rates can be as high as 24.35%. Securing a lower, fixed interest rate with a traditional debt consolidation loan might sometimes be a more predictable alternative, with rates typically ranging from 6% to 36% APR.

Applying for a new line of credit will result in a hard inquiry on your credit report, which can temporarily lower your credit score by a few points. However, responsible management of the line of credit, characterized by timely payments and keeping utilization low, can positively impact your score over time. If considering a HELOC, understand the implications of using your home as collateral, as this places your property at risk in case of default.

Personal lines of credit may include origination fees, annual fees, or transaction fees, while HELOCs can involve closing costs ranging from 2% to 5% of the credit line, along with potential annual or inactivity fees. It is also crucial to assess your repayment discipline; consolidating debt is only effective if you commit to a strict repayment plan and avoid accumulating new credit card debt. Ensure the line of credit limit is sufficient to cover your existing credit card balances, and consider how this decision aligns with your broader financial objectives.

Executing the Debt Consolidation

Begin by applying for the line of credit through a bank, credit union, or online lender. This application typically requires submitting personal financial information, including income verification, and will involve a credit check.

After approval, funds from a personal line of credit are usually accessible via direct deposit into a checking account, checks, or sometimes a dedicated debit card. For a HELOC, funds are often accessed similarly, allowing you to draw from the approved credit limit as needed. The next immediate action is to use these funds to pay off your high-interest credit card balances.

Following this, it is essential to establish a clear and disciplined repayment plan for the line of credit itself. This plan should prioritize consistent, on-time payments, ideally exceeding the minimum required, to reduce the principal balance and interest charges efficiently.

Other Debt Management Strategies

One common approach involves balance transfer credit cards, which offer an introductory 0% APR period for a set duration, often ranging from six to 34 months. These cards typically charge a balance transfer fee, usually between 3% and 5% of the transferred amount.

Another option is a debt consolidation loan, which is a fixed-term, fixed-rate installment loan used to combine multiple debts into a single monthly payment. These loans can offer interest rates from approximately 6% to 36% APR, depending on creditworthiness, and may include origination fees. Unlike revolving credit, once the loan is repaid, the account closes.

Debt Management Plans (DMPs), facilitated by non-profit credit counseling agencies, provide a structured repayment schedule. Agencies negotiate with creditors to potentially lower interest rates and waive fees, allowing for one consolidated monthly payment to the agency, which then distributes funds to creditors. DMPs typically involve a one-time setup fee (averaging $39-$52) and monthly administrative fees (averaging $24-$50). Finally, personal repayment strategies like the debt snowball method (paying smallest debts first) or the debt avalanche method (paying highest-interest debts first) can be employed independently to systematically reduce debt.