What’s the best way to get rid of $35,000 of credit card debt?

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Q. I have a “friend” who has dug a hole for himself. He’s been irresponsible. He is married, has a house with equity of $100,000 about the mortgage. He somehow compiled $35,000 or more in credit card debt and his credit score is below 600. He signed with a credit settlement company but has 30 days to get out of it, which I advised him to do. He could refinance the house and pay the debt, try to get a home equity line to pay the debt or try to consolidate the credit cards with zero percent deals. What do you suggest?
— Trying to help

A. Your advice to try to get out of this situation as soon as possible is spot on.

The interest rates credit cards charge for running balances can be 20% or higher and can put a real strain on your financial health. And now that we’re in the age of coronavirus, employment is uncertain for so many people. We hope he’s been able to keep his job.

However, although it may seem irresponsible, it’s easier than you realize to get yourself into trouble, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

“Simply put, credit cards let you spend more than you make,” he said. “Without proper discipline, it is very easy today for people to outspend their earnings.”

That being said, going to a credit settlement company would likely hurt his credit even more, so that should be the last scenario he explores, DeFelice said.

DeFelice said you can probably cross off the list the idea of consolidating the card balances on a zero percent credit card. With a credit score below 600, he won’t be receiving any zero percent offers, he said.

With a credit score that low, he will also have a difficult time getting approved for what is referred to as a cash out refinance on a conventional mortgage, which is basically refinancing the existing mortgage plus the amount needed to pay off the credit cards, he said.

“The amount above the existing mortgage debt is provided at closing in the form of a check to the borrower, which he would in turn use to pay off the credit cards,” he said. “FHA would be his only option with a low credit score, and for cash out ref’s you need to be at 620 or higher currently and maintain at least 80% equity in the home after the cash out.”

Additionally, he said, the lower your credit score, the higher your mortgage rate will be, and even at 620 it will be a higher monthly payment than what one could get with a healthy score.

His best bet may very well be applying for a home equity line of credit.

Home equity lines are typically based on the prime rate, which is currently at 3.25% after the Fed reduced rates in response to the coronavirus pandemic, DeFelice said.

“If he can qualify for a home equity line, he should be able to get the money he needs to pay off all the credit cards,” he said. “That move alone will increase his credit score as well as save him a ton of money in interest.”

However, unlike traditional 15- or 30-year fixed mortgages, home equity line rates are variable, and will move up as the prime rate goes higher – thus creating a higher monthly payment, he said. While it looks like interest rates will stay low for the short term at least, they will likely increase in the future as the economy gets back on its feet.

“As he continues to make payments on the home equity line and his credit score improves, his longer term goal should be to then refinance to a traditional 15 or 30 year fixed mortgage to lock in rates before they rise much higher once his credit score improves,” DeFelice said.

Your friend should shop around for the best rates on home equity loans, starting with the banks he already does business with. Another option would be to find an independent mortgage broker who can shop around for the best rates and do all the legwork for you, he said.

“A good mortgage broker can also advise which institutions would be most likely to give you the best rate with a low credit score,” he said.

Good luck to your friend.

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This story was originally published on April 1, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.