We recently spoke with a CPA and the author of many books as well as a Q&A online column dealing with issues involving credit and finance about selling a house to use the equity to pay off current debts. Her answer might surprise you.
This is a regular and interesting question that has come up many times before from homeowners who want to make the best moves they can for themselves financially.
“Currently we have over $110,000 of equity in our home. Would selling it and using the equity to get rid of our $25,000 worth of debt be a smart move financially?”
Selling your home to get rid of old debt is probably not your best solution, for at least three reasons:
- The process simply costs too much
- Buying another house will take time and money
- The largest investment you have will take a major hit
This example comes from a couple who had both gotten bad credit scores from the loss of job a couple of years ago. They kept afloat by leveraging other sources of debt until, eventually, they lost everything.
Now that they have gotten back on their feet and established about $110,000 in equity in their current home and have a steady income they want to know if it would it be wise to sell their house to wipe out the $25,000 worth of debt? Also if they do that, what comes into play with their credit score and purchasing another home or would it be better to wait it out a while?
From the information provided, however, the expert stated that this plan of selling your home is probably not your best solution. Unless there are other reasons you want to get rid of the house, I strongly urge you to keep it.
Why selling your home is not a cost-effective way to pay off old debt
Selling your house will be cost-prohibitive. Have you ever seen the interest rates on a $30,000 credit card? You won’t believe your eyes when you see the costs related to selling a house. If the fair market value of your house is $400,000 once you pay the commissions to agents, the costs for the closing (some of the buyers costs are often passed along to the seller as well) and sales tax, if applicable, you can end up losing 8 to 10 percent of the sale off the top. It could easily cost you $40,000 to sell your house so you can pay off $25,000 in debt. This doesn’t include any fix-up costs for getting your house ready to sell or repairs you may be required to make after the inspection.
Buying a new house takes a lot of time and money. It normally takes as much as 3 months and sometimes even longer to pack up, locate and purchase a new house and then get yourself situated again. A better idea would be for you to work overtime at your job or get a 2nd part-time job and with that money, you could pay down your debts. On top of all that your new house comes with, fees to originate the loan as well as other loan-related expenses, the costs for appraisal and closing costs. When you crunch the numbers you can easily spend up to 5 percent of the cost of your new home. For a $400,000 home, that would be $20,000. Now when you add in incidental expenses needed for getting into your new home, you can see that selling your house and using the equity to pay down your debts is not a cost-effective way to pay off a $25,000 debt.
Your best investment takes a huge hit. Your best and most valuable investment is going to be your home. Once you get to retirement and beyond, it often becomes your only real investment. Pulling the equity out of your current home is a real pain in the butt and that's a good thing because it makes it more likely you will leave it alone. Just focus on paying down the mortgage down and keep allowing the price to go up, and this single investment can take care of you when you are older.
What about some of the other ways to pay off debt?
So, forgetting about selling your home to fix this situation, what's the best way to handle this debt? Taking bankruptcy, unless you are completely overwhelmed would not be a good plan long term or short term.
One great way to get a great start paying off your debts is to sell something of value and use the proceeds toward your debts. You could even use any larger sum proceeds to negotiate with your debtors. If you don’t know where to find something that you sell, your driveway might be the best first place to look.
Do you have more than one car? Are you making monthly payments on any of them? Becoming a one-car family for a while could make all the difference. Now you can begin to use what you’re saving from those monthly payments to pay more on your balances. Any questions you have about money, debt and finances, find a credit counselor in your area.
It's quite likely you qualify to enter a debt management plan. Once you join, the credit counseling agency will work with you to create a plan to repay your debt and a strategy that can instantly stop collectors from calling you, helps reduce fees and you can begin to pay off your debt in a way that is manageable for you. Any agency that not for profit and affiliated with the National Foundation for Credit Counseling or the Financial Counseling Association of America is good. They will be able to explain your best options given your situation and give you a plan to solve your debt issues, and you can keep your home if you want to.