Jingle Bills, Jingle Bills, Now It's Time To Pay?

by Michael Eastham, CPA CRMS

Now that the holidays are over, can you breathe a sigh of relief? For many of us it is very easy to succumb to the holiday temptations and overindulge in just about everything--parties, food, fun, and of course, spending. 

Soon you will be receiving that first holiday credit card bill, which will include the first wave of your holiday extravaganza. What do you do now? Well, there are several ways to approach this dilemma. With interest rates remaining at a 40-year low, it is still a terrific time to consider tapping into the equity in your home for a debt consolidation loan. Now, before I get too deep into this, let me deliver a caveat. I am a huge advocate of responsible spending, so I tend to be very careful when it comes to making specific recommendations. I will be the first to admit that using your home’s equity in this manner is not right for everybody. However, when used strategically as a part of a well thought out plan, it can be a very useful tool.

One big advantage--when you pay interest on a loan secured by your residence, it can be completely tax deductible. Interest paid on credit cards is not. My theory is, if you are going to pay interest anyway, you might as well take advantage of the benefits in the tax code that are designed to help homeowners lower their taxes.

only on the amount of the line that you have tapped into. Terms can vary significantly among lenders, so you must make sure that you understand the details. Some will allow you to draw on the line for a certain period of time, say five years with interest only payments, and then will require you to pay the amount drawn over the next 10 years. Others are interest only for the entire life of the line and then the entire amount becomes due.

Another option is a Home Equity Loan, which is very similar to an installment loan, but is secured by the equity in your home. With this type of loan, your loan term will be fixed for a defined period of time with your payments including both principal and interest, just like a car loan. Additionally, you can expect the interest rate on this type of loan to be higher than that of the HELOC, but it will be fixed rather than adjustable. While you have very little flexibility with a straight Home Equity Loan, it can be effectively used for larger purchases, like a car or home improvements, since they require that you pay the entire amount back on a fully amortized basis, such as 10 or 15 years.

A third option is to consider a loan that combines features of both of the aforementioned options. It has a HELOC component as well as a fixed component. This type of loan program actually has different interest rates, depending on how you use the money. If you choose the HELOC component, you will make interest only payments during the draw period; if you choose the fixed rate component, you will be required to pay both principal and interest with each monthly payment with a higher, fixed interest rate. This can be very helpful, for example, in paying off a car loan with a tax deductible loan and having the HELOC take care of some shorter term debts, such as credit cards or other consumer loans that have crept up on you during the holiday season or before.

The costs for these options will vary, but in some circumstances, you can get a HELOC set up basically for free.

If the holiday spending has got you starting the New Year with some new budgetary goals, it makes sense to explore one of the options mentioned here. Any of them can be used as an effective tool in your financial tool belt. With interest rates still very low, these options can help you to accomplish your strategy for 2005.