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Tough choice: Sell home to pay off debt

Rob Goebel/CreditCards.com

Rob Goebel/CreditCards.com

Your home is your castle, but it could also be your ticket out of debt. While not a decision to take lightly, there are circumstances when selling your biggest asset to pay off creditors may make sense.

Today, a growing real estate market makes a home sale a more feasible debt relief option than it was in the years following the recession. In May 2016, the National Association of Realtors announced that home sales and prices were both up about 6 percent over the previous year. “Homes in good condition and priced well are selling very quickly,” says Sandra O’Connor, a real estate agent and past president of the North Carolina Association of Realtors.

In fact, a home sale helped Charles Phelan, founder of ZipDebt, a company that offers DIY debt settlement tools to consumers, when he and his wife found themselves deep in credit card debt. In 2010, the couple bought their dream home, a sprawling ranch with amazing views in Escondido, California. Soon after, their finances took a double hit with her illness and his business downturn.

To meet their living expenses after making hefty mortgage payments, they pulled out the plastic and racked up $63,000 in debt. “We were house poor,” Phelan says.

After thinking through every angle, in 2014 the couple decided to sell their home to pay off their debt and move into a less expensive place. “It was one of the smartest financial decisions I’ve made,” Phelan says.

Keep or sell: 5 key questions
Selling a home to pay off debt isn’t for everyone, or the necessarily the right solution. “The decision is always going to be specific to the person and their financial situation,” Phelan says.

To know if selling makes sense for you, it’s important to look at the big picture of your finances, home and life goals. Here are five questions to ask if you’re wondering if selling your house to pay off debt is the right decision:

1. Can you afford to stay in your home? A general rule of thumb is that no more than 31 percent of your gross income should go toward your home, including mortgage payment, property taxes, home insurance and maintenance costs, says Sherry Tetreault, a certified credit counselor who does housing counseling for ClearPoint Credit Counseling Solutions. So, what do you do if a much larger chunk of your income is going into your home? “You may be living in a home that’s beyond your capabilities,” Tetreault says.

In Phelan’s case, selling made sense because his dip in income put the ratio out of whack. “If you’re out of alignment on the ratio, you really need to think of selling the house to get out from under that burden,” he says.

2. Will you make a profit if you sell? It’s key is to know if a sale will net you enough cash to pay off your debt. If you’ve owned your home for less than five years, the value of your home may not have appreciated very much, O’Connor says. Of course, your equity also depends on how much money you put down and how much you’ve paid off, but in the first years of a mortgage, a higher proportion of your monthly payment is going toward interest rather than principal.

3. Where will you live after you sell? You may have to downsize or move to a more affordable area, or both, for selling to make sense, says Kelley Long, a certified financial planner with Financial Finesse, a company that offers financial education and coaching. It’s worth thinking through future living scenarios carefully, Tetrault says. For example, if you’ve lived in a quiet single-family home in the country, it may be tough to move into an apartment with noisy neighbors nearby, she says.

4. How’s your credit? If you have shaky credit, that could throw a wrench into plans to rent or buy a new home after you sell, Phelan says. If your score is bad enough, a landlord may not rent to you, or you might not be able to get a loan to buy a new home.

Of course, the debt itself may be dragging down your credit score by affecting your credit utilization ratio, as it did for Phelan, who was shocked when he got turned down for a Visa he tried to open to buy items to stage his home for the sale. Keep in mind that it takes time to get the proceeds of the sale, pay off your debt and have that reflected on your credit report, Tetrault says. If your score is pristine, selling your home to pay off debt may be one way to keep it that way, which is one reason some consumers go that route, she says.

5. How will selling affect your goals for the future? Your age and future plans are another factor to consider, Long says. If you’re nearing retirement age, and you’ve got your house paid off or almost paid off, selling and handing the proceeds over to your creditors could put you in a position where you’ll have to come up with a mortgage or rent payment each month after retirement. And it’s possible that your annuities, Social Security payments, pension or other sources of retirement income might not stretch that far, Long says.

Other ways to tap your home to repay debt
If selling your home isn’t right for you, you may still consider tapping your home equity to pay down debt. You'll need to have more home equity than debt, and sufficient income to repay the loan.

Personal finance experts often urge consumers to think twice before turning to home equity to pay credit card debt. Essentially, you’re trading unsecured debt for debt secured by your house, Long says. “If you stop making payments, you could lose your home,” she says.

But if that's the route you choose, there are two major ways:

  • A home equity loan or line of credit – Both a home equity loan and a home equity line of credit (HELOC) allow you to access part of your home’s equity, which you can use to pay off higher interest debt. A home equity loan, also known as a second mortgage, typically offers you a lump sum at a fixed interest rate while a HELOC allows you to withdraw money from a lump sum when needed at a variable interest rate. The upside of both: interest is usually quite a bit lower than on a credit card, and may be tax deductible, Long says. The downside: you’re risking your home. If you’re OK with that risk, a home equity loan may be a better option for paying off credit card debt because you lock in the interest rate and payment amount until the debt is gone, while a HELOC is revolving, including variable interest, which makes it more challenging to budget for your payments, Long says. Also, with a HELOC, if housing values go down, the bank can call in the loan and you may have to pay it back in bigger chunks sooner, Long says. “A home equity loan may be the safer option,” she says.

  • A refinance – A standard refinance at a lower interest rate could lower your mortgage payment and give you more money each month to put toward debt repayment. Or, a cash-out refinance lets you take part of your equity as a lump sum, which then gets tacked onto your mortgage debt. If you do refinance your home, avoid extending the term in order to lower your monthly payment because you’ll pay much more interest in the long run, Long says.

Tips for selling your home to repay debt
If you’ve decided to sell your home, start by setting up an appointment with a local real estate agent who can give you a realistic idea of how much your house will sell for and how quickly, O’Connor says.

Make sure the agent has recent experience listing and selling homes in your area and has actually set foot inside the homes he or she is using as “comparables” to determine the listing price of your home, she says. It’s key to know ahead of time how much profit you can expect to make from the sale so you can plan accurately, Phelan says.

Once you’ve got a good idea how much you could make, add up all the costs of selling the home and moving. Costs may include staging, repairs, and broker and real estate agent fees, O’Connor says. Moving costs may include a moving company; a deposit on a rental or down payment and closing costs on a new, more affordable home; and utility fees, Tetrault says. Phelan kept a running spreadsheet to track all those numbers, alongside his mounting debt. “Crunch the numbers very thoroughly,” he says.

Then see what you have left to pay off your debts. If the math doesn’t work in your favor, selling could be a painful endeavor that could create more problems than it would solve.

Eliminate the root problem
It’s crucial to figure out why you got into credit card debt in the first place so you can change your patterns. For example, if you’re charging too much, you need help creating and sticking to a budget. If you are facing a job loss or medical crisis, relying on credit can be a temporary solution, but can spiral out of control if the issue isn’t resolved soon.

Whatever your situation, it’s important to explore all available options and reach out for the help you need to avoid getting sucked in a debt spiral. “There’s nothing worse than selling your house, moving, and then ending up back in credit card debt again,” she says.

Final considerations
And finally, consider your feelings about selling. “A home may be brick and mortar, but it’s where family members have gathered and memories have been made,” Tetrault says. “There are roots there.” That’s why some consumers experience “emotional upheaval” when they put a house on the market to pay down debt, she says.

It was hard for Phelan to let go of his dream home, but it came down to the math, he says. “My home was holding me hostage financially,” he says.

See related: 8 ways to sidestep high medical debt, Get through unemplyment without borrowing