Credit card use continues to grow, with an average of 6.3 bank credit cards and 6.3 store credit cards for every household, according to Cardweb.com Inc., which monitors the industry. As a result, there is a “fee feeding frenzy,” among credit card issuers, said Robert McKinley, Cardweb’s president and chief executive, with credit card companies imposing fees and increasing interest rates if a single payment is late. Penalty interest rates usually are about 30 percent, with some as high as 40 percent, while late fees now often are $39 a month, and over-limit fees, about $35, McKinley said.
Bankruptcy used to be the way people got out from under burdensome credit card debt. But, under the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 filing for bankruptcy is prohibitively expensive, complicated and time consuming. This is why closed-end home equity loans (second mortgages) have become popular ways of refinancing high-interest credit card debt, particularly for those with low credit scores.
Credit cards are not secured by your home. But then, the interest is not tax deductible. Most second mortgages and home equity lines of credit (HELOCs) have mortgage interest that is tax deductible. Second mortgages have simple interest; credit cards have compounding interest. Wikipedia defines compound interest as interest which is added to the original principal. New interest is then calculated, not only on the principal, but also on the interest that has been added. In short, compound interest is interest earned on interest.
Principal balances go down a lot faster when paying on simple interest loans because the interest is only paid on the principal balance. Credit cards are revolving, most second mortgages have fixed interest rates and are considered closed-end loans, because you borrow a lump sum and start repaying it immediately. Credit cards are open-end loans, meaning you can repeatedly draw from the line up to the credit limit.
Many people argue that the repayment period for a closed-end second mortgage is longer than that of credit cards. But, with penalty rates and fees tacked onto the compounding interest, many consumers are getting caught in the spiral of “negative amortization,” which is what regulators call it when consumers make payments but balances continue to grow because of penalty costs. The new bankruptcy laws forced credit card companies to double their minimum payments, but that’s not enough to reduce the principal quickly enough for people to pay their balances off in a timely manner. Instead, their balances continue to grow. So, it makes sense to go ahead and use the equity in your home to end this cycle by paying off credit cards with a closed-end second mortgage.