Why You Should Refinance Your Home to Consolidate Credit Card Debt

Debt is a big problem for many Americans. It is especially taxing for people who have credit card debt on top of a home loan. US households had an average of $15,700 in credit card debt in 2015 with an interest rate of 14% on average. But interest rates in 2018 usually top 20%.

You might think there is no way to get relief from high credit card balances, but you can refinance your mortgage to consolidate your credit card debt.

Using Lower Rates to Consolidate Debt

Mortgage rates are not as low as they were three years ago, but you can still refinance your mortgage for 5% or less, which is much lower than rates of 20% or more on credit cards. If you can lower your interest rate by 15% on $10,000 of debt, you can save yourself $150 per month in interest.

You can do this by refinancing your first mortgage and taking out some of your equity. Many like to do this so they can make fixed payments over a fixed period, instead of paying on a revolving balance every month.

How to Do a Refinance the Right Way

If you believe a cash out refinance might be the way to go, be sure you have enough equity that the cause that you take out will not leave you with more than an 80% loan to value ratio. Exceeding 80% will mean you probably have to buy PMI. This can cost you 1% or more of the loan value each year. On a mortgage of $250,000, that would cost you $2500 per year.

To arrive at your loan to value ratio at present, you need to divide your current mortgage balance by the rough value of your home. For example, if you have a current mortgage balance of $300,000 on a home that is valued at $450,000, and you want to pay off $15,000 in credit card debt, it would be $300,000 + $15,000 divided by $450,000, or 70%.

As your loan to value ratio is below 80%, you can cash out enough of your equity to pay off credit card debt without needing mortgage insurance.

Possible Downsides

When you do a cash out refinance to pay off debt, remember that you are boosting your mortgage balance by the amount of debt you are paying out. This will cause your loan amount to rise, and could increase your monthly mortgage payment, depending upon the rate you get.

Second, note that interest rates have been on the rise, and fewer people are refinancing first mortgages today for that reason. It does not make sense to swap a 4% mortgage for a 4.8% mortgage. In this case, you may want to tap equity with a second mortgage – a HELOC or home equity loan.

Also, think about how loan your mortgage is. If you already paid down several years on your mortgage, you may not want to extend the loan to 30 years again. Rather, consider dropping the term to 25 or 20 years. The shorter term would lower the rate and save you much in interest. But you could have a higher payment.

The last factor to consider on the downside is closing costs. A mortgage refinance will cost several thousand dollars in closing costs. Whether you pay this in cash at closing or wrap it into the loan, it is definitely a cost to be considered.

Last, remember that for some, consolidating credit card debt with a mortgage refinance leaves them with available credit card lines to run up again. Without proper discipline, you can have both maxed credit cards AND a higher mortgage payment, plus your house is now on the line if you do not make payments. The lesson: Refinance your home to consolidate debt with thought and care.

References

https://www.nerdwallet.com/blog/mortgages/refinancing-mortgage-pay-off-debt-right/