Credit cards may be a convenient source of on-demand financing, but high interest rates, sometimes exceeding 30%, have many cardholders looking for ways to clear outstanding balances. By consolidating high-interest credit card debt under a lower-cost fixed loan, many customers can use loans from home equity, retirement plans and even life insurance to cut credit card costs.
Home Equity
Homeowners who have considerable amounts of credit card debt may find that the easiest and most beneficial way to consolidate the outstanding balance is through a home equity line of credit, or a home equity loan. Because the homeowner's own house is used as collateral to secure the loan, equity loans carry a considerably lower interest rate than credit cards, sometimes as low as 5 to 8 percent. Even better, the small amount of interested racked up by a home equity loan is tax deductable, creating an added cost savings at tax time.
Homeowners who choose to consolidate high-interest credit cards under a home equity loan should use extreme caution in doing so, as the potential does exist for some debt-laden consumers to jeopardize their homes using this method (some borrowers pay off credit cards with a home equity loan, but then run up new balances on the freshly cleaned credit cards). To get the most benefit from a home equity loan, borrowers should cancel existing credit cards after paying them off, perhaps saving one or two, preferably with low limits, for use in emergency situations.
401(k) Loans
Credit card debtors who have a 401(k) retirement plan may find that a 401(k) loan is a preferable method for quickly paying off outstanding credit card debt. Many 401(k) plans allow participants to take a loan of up to 50% of the retirement account balance, payable in monthly installments over a period of up to five years. While loan and repayment options vary, typical interest rates are one or two points above the prime rate, making repayment affordable for most debtors (and, certainly, cheaper than credit card debt). There are certain tax penalties that a borrower may incur when using a 401(k) loan, most obviously the repayment of the loan with after-tax funds. In addition, debtors who borrow against their retirement plans should use caution to ensure that high-rate credit cards are destroyed or accounts closed in order to avoid temptation to incur additional card debt.
Life Insurance Loan
Debtors who have life insurance featuring a cash value may have the option to borrow against their policy. When borrowing against life insurance, the insurance company essentially "fronts" money that would be paid out when the policy-holder passes away, giving the debtor an opportunity to use the money while still alive. While the prospect sounds promising, the advance is a loan and must be repaid with interest; if the borrower should pass away (even if unexpectedly) before the loan is repaid, the outstanding balance and any interest will be deducted from the policy payout. In extreme cases, this situation could render surviving family members unable to pay funeral and burial expenses. Still, the comparatively low interest rates of life insurance loans make them an attractive option to debtors facing high credit card balances.
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