Using a HELOC To Pay Credit Cards: Legal Risks and Rules

Using a home equity line of credit (HELOC) to pay credit card debt may offer a lower interest rate and more flexibility than other lines of credit. It also puts your home on the line if you don’t repay it according to the agreement. Before you sign on the line, it’s important to understand exactly what happens when you shift unsecured debt to secured debt, the federal protections available, and the risks.

If you need legal advice regarding whether you should use a HELOC or assistance after you have obtained a HELOC, you can visit the Super Lawyers directory to look for an experienced debtor and creditor rights lawyer near you.

What Is a HELOC?

A home equity line of credit, sometimes called a second mortgage, is a revolving line of credit secured by your home equity, with a flexible draw period and a repayment period. As you repay the balance of the home equity loan, you may be able to withdraw money from the line of credit as you would with a credit card.

Borrowers can use a HELOC to pay off multiple credit card balances, consolidating them into one payment. There are several appealing aspects of HELOCs to homeowners; these include:

• Generally lower interest rates than some other lines of credit, including credit cards
• The potential for a single monthly payment through debt consolidation
• Possible improvement to credit utilization, which could improve your credit score

These features make it a flexible option for debt consolidation, unexpected expenses, or renovations.

HELOC: Shift from Unsecured to Secured Debt

All debt is not created equal. Credit card debt is an unsecured loan, meaning it has no collateral or assets backing it up. A HELOC, on the other hand, is a secured loan. Your home is the collateral for a HELOC, meaning you can borrow against your home’s value.

There’s a tradeoff with a HELOC, though. You may be able to obtain a better interest rate than that for a credit card or a personal loan, but you convert the debt your lender could not seize into debt backed by your property.

This means defaulting on HELOC payments can lead to foreclosure, which is not the case with credit cards alone. Deciding whether to get a HELOC is a strategic choice, not simply a rate comparison.

Truth in Lending Act (TILA) Disclosures That Lenders Must Provide

The Truth in Lending Act (TILA) is a federal law standardizing how lenders disclose credit terms. It provides a list of core disclosures for a HELOC:

• Finance charges
• Payment terms (such as interest-only payments or balloon payments)
• Annual fees and closing costs
• Early termination penalties
• The conditions under which the lender may change the terms

Certain disclosures must be provided when you receive the application or shortly after that. Fees vary widely among lenders, so be sure you understand them, especially as they may affect creditor and debtor rights.

How the Annual Percentage Rate (APR) Is Calculated

The annual percentage rate, or APR, is the yearly cost of credit expressed as a percentage. It reflects interest and certain fees.

Because the APR includes the interest rate and fees, such as annual fees, it provides a more accurate cost comparison than the interest rate alone. APR disclosures can show the current interest rate, plus how it can change.

Variable Rate Term Disclosures

Most HELOCs have variable interest rates tied to an index. Regarding lender disclosures about interest rates, these typically include:

• The index used
• The margin
• How and when the rate can change
• Historical rate examples

Because your payments can increase over time, read the terms carefully. For instance, lenders can offer introductory APRs that start low to attract borrowers but increase over time. Make sure you are comfortable with the starting rate and the cap rate (the potential maximum rate).

Your 3-Day Right of Rescission Under TILA

With a HELOC, you have the statutory right of rescission. This means that for many home-secured credit transactions on a primary residence, you have three business days to cancel. Because the repercussions of defaulting on a HELOC involve putting your home at risk, the three-day right exists for protection.

How the Three-Day Window Works

After you sign the contract for a HELOC, receive the disclosures, and receive two copies of the rescission notice, the three-day window begins. “Business days” typically include Saturdays but exclude Sundays and federal holidays. To cancel, you must provide written notice within the window. If you cancel properly, you owe no penalty, and the lender must return fees.

What Happens After You Cancel

Once the loan is canceled, the lender must cancel the security interest in your home and refund the charges. The lender should not disburse funds until the rescission period ends. A verbal cancellation is not enough. For cancellation to be effective, it must be in writing.

Adjustable-Rate Margin Rules and Interest Rate Caps

When your loan is tied to an index (a benchmark rate) plus the margin (the lender’s fixed add-on), this equals your interest rate. When the index moves, your rate moves with it. So, a rising index increases your monthly loan cost even though the margin stays fixed.

Interest Rates Caps

Interest rate caps determine how much your interest rate can rise, including per-adjustment caps and a lifetime cap. Lifetime caps are significant because they represent your maximum exposure. During the loan application process, it is wise to understand periodic caps and rate floors.

What To Watch Out for During the Life of the HELOC

If you have a long-term draw, rates may rise. Additionally, payments can jump during the draw period when compared to the repayment period. Concerning a HELOC, it’s helpful to keep track of the following:

• Index
• Margin
• Adjustment frequency
• Pre-adjustment cap
• Lifetime cap
• Any floor

HELOC terms may be complex or unclear. An attorney can review the loan agreement and confirm compliance with TILA. They can also identify hidden fees, predatory lending practices, or unfavorable terms.

Find a Debtor and Creditor Rights Attorney for Your Needs

Weighing the rewards against the risks of using a HELOC to pay credit cards can be challenging. The fact is, a HELOC can lower your interest costs on the one hand, but converts unsecured debt into debt secured by your home on the other hand. If you need legal help with any aspect of a HELOC, you can visit the Super Lawyers directory to look for an experienced debtor and creditor rights lawyer near you.