Home prices have literally gone through the roof in Canada in recent years. If you’re lucky enough to have entered the market a few years ago, you’ve built up some equity. But what if you have other, not so good debts, like credit cards, overdrafts and tapped out lines of credit? How should you use the equity in your home to deal with this debt?
If you do have equity in your home, you have three potential options to pay off excess unsecured debt:
- Sell your home, cash in the equity and pay off your debt.
- Use the equity in your house to support a debt consolidation loan to amalgamate multiple old debts into one new, hopefully lower cost, debt.
- Depending on how severe your debts are, consider something called a consumer proposal.
Each alternative comes with its own pros and cons and choosing the best alternative means doing a cost-benefit comparison based on your individual situation. Let’s look at some of the considerations.
Can you afford to maintain your home?
The very first step is reviewing your budget to see if you can afford the ongoing costs of keeping your house. If your unsecured debts came about because of other spending problems or you were out of work temporarily, but things have returned to normal and you expect you can now keep up with your mortgage payments, selling your home may not be the best option.
If, however, your home is one of the main reasons your budget is now out of balance, perhaps because your income was permanently reduced due to retirement or a job change, then you need to make the hard decision to sell and downsize. Dealing with old debts, while continuing to pile on more to make ends meet each month, doesn’t make long-term sense.
Will you realize enough to pay off all your debts?
Let’s assume you can afford to keep your home. The next question becomes should you sell anyway in order to pay off your other debts and effectively start over? This may only make sense if you truly are able to begin again without any other unwanted debt.
If you owe $50,000 in credit card debt and only have $35,000 equity in your home, selling your home won’t solve all your problems. Once again, you need to look at your budget and decide if selling your home and relocating (you have to live somewhere) will save enough that you’ll be able to repay the additional $15,000 you owe in a reasonable period of time.
Interestingly, this is the same analysis you need to make when considering a debt consolidation loan. If taking out a second mortgage on your home doesn’t consolidate all of your existing unsecured debts and balance your budget, then it might not be the best choice.
Are your debts too large to deal with on your own?
Finally, if selling your home (or taking out a debt consolidation loan) won’t cover all of your debts, and repaying the excess will take too long, then it’s time to consider options that will help you eliminate all of your debts now.
If you have equity in your home, a consumer proposal filed with a bankruptcy trustee is a way to use that equity to negotiate a settlement agreement with your creditors. In a consumer proposal, you’ll end up paying less than you owe, yet all of your unsecured debts are eliminated.
So in our original scenario you may be able to negotiate a payment plan with your creditors to pay them $35,000 to $40,000 and walk away from $50,000 in debt. In a consumer proposal, you can keep your house if you decide you can afford to or you can sell your home and make a lump sum settlement offer. The point is, your debts are eliminated no matter how much equity you have. So if you owe more than the equity in your home, this is a great option to consider.
The best approach is to talk with a professional such as a bankruptcy trustee. They can help you review the numbers and choose the right solution for you.
Flickr: Ian Muttoo