Is refinancing to pay off credit cards a good idea?

I hear many banks and loan companies trying to convince homeowners to take out loans against their homes to pay off various kinds of debts, such as credit cards, medical bills, or student loans. This can make sense in some situations, but anyone thinking about doing this should be aware of one thing: you are trading unsecured debt for secured debt.

Secured debt means that there is collateral for the debt. Examples include a home mortgage or a car loan. If you fail to make required payments, the creditor can seize the collateral from you, meaning that you could lose your home or car.

Unsecured debt is different, because there is no collateral. A creditor’s rights will vary according to state law, but as a general rule no court order is required to seize collateral. On the other hand, a creditor who seeks to collect on an unsecured debt usually must first go to court and obtain a judgment—that is, a court order that says you owe the money. And before that can happen, you have the right to be notified of the lawsuit and to contest in court whether or not you owe the money.[1]

Even with a judgment, the creditor may be limited in the ways he can try to collect on that judgment, depending on state law. (For example, some states permit garnishment of a portion of a debtor’s wages to pay a judgment, while other states do not.)

Secured debt and unsecured debt are treated differently in bankruptcy, too. Unsecured debt can often be partially or wholly discharged in bankruptcy. But even in bankruptcy a creditor will usually be permitted to take back his collateral unless you reaffirm—that is, agree to pay—the debt.

So if you are considering taking on secured debt to pay off unsecured debt, you may want to talk to a lawyer first so you can make a fully informed decision.

(The foregoing is for purposes of education and information only, and is not intended as personal legal advice. Please consult with an attorney. Don is a retired Texas attorney. For more on his background, click here.)

[1] You can lose those rights if you cannot be found (and thus, can’t be notified), if you avoid service of process, or if you fail to come to court when you are supposed to.