Stop the Debt Shuffle, and Figure out why you owe so Much

Dear To Her Credit,

Like so many people, we have card debt of approximately $55,000. We also have a home equity loan of $31,000. I have no mortgage on my home. I have a $15,000 whole life insurance policy on my husband that I was going to surrender for $11,000 and pay off some debt. I am now thinking of taking a loan against it instead. I also want to try to get another home equity loan to pay off the first one, which I can't draw on anymore. I would appreciate your advice.

- Clarissa

Dear Clarissa,

You are right, many people have credit card debt these days. However, $55,000 in card debt is more than a normal amount for most people. That much debt could indicate a serious problem, especially since you are talking about shuffling money around to try to cover it.

Before you try to pay off debt, you need to find out why you have it in the first place. Some people get into debt during a period of unemployment or illness. When their situations improve, they get rid of the debt as quickly as possible.

Other people simply have more expenses than income. If they are retired or close to retirement, they may have lots of debt and practically no income. Borrowing from one account to pay another only delays the inevitable day when they can't borrow anymore from anywhere. Sooner or later, they've borrowed all they can.

Your best course of action depends on whether you fall into the first group -- the people who ran up debt but will be able to pay it off in a reasonable time -- or the second.

Assuming you and your husband still have good earnings prospects for a substantial number of years to come, I recommend getting a new home equity loan at a low interest rate to pay off the card debt. You should only do this if you can avoid using the cards again -- otherwise, you'll be in worse shape than before, with another home equity loan and new card debt.

Another option is to refinance your home and pay off all your debts. The interest rate is bound to be lower than you are paying on the credit cards. It's a shame to have to get a new mortgage on your home when it was paid off, but the money on the cards has already been spent. Consider getting a shorter-term mortgage. Very few people make more than the required monthly payment on their mortgages, despite their best intentions. You don't want to be paying off this debt for the next 30 years.

If you are near or at retirement age, you might consider a reverse mortgage with enough cash at the beginning to pay your debts. Be aware that, like any loan, a reverse mortgage costs money to set up. In addition, you will have a mortgage on your home, which you may not want if you planned to leave the home to your children. Either way, I suggest you talk to a trusted financial adviser to explore all the options and ramifications of tapping the equity in your home to get rid of your debt.

I'm glad you decided against cashing in your whole life insurance policy. Surrendering a $15,000 policy for $11,000 would be giving up 25% of the value of the policy. Borrowing against the policy is probably not your best move, either. You won't get enough cash to pay off your bills, and then you'll have to pay interest on the amount you borrow.

If your prospects of being able to pay off your debts are dim, you might consider settling your debts (negotiating with your card issuers to pay less than what you owe) or even filing for bankruptcy. Either of these options should be a last resort. They will hurt your credit score, and therefore your ability to get more credit at a reasonable interest rate in the future.

With a serious level of debt and so many unknown variables, I recommend that you find a nonprofit agency affiliated with the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies to help you sort it all out. They can help you review your options and compare the costs and risks of each one. Your financial future is at stake -- make sure you're solving your financial problems, not just pushing them further into your future.