Thinking about refinancing your mortgage to pay off credit card debt? Don’t jump too fast. There are factors that make such a financial leap a very bad idea.
On the face of it, it seems a good idea to swap “bad” credit card debt for an extension of your mortgage, which is generally viewed as “good” debt. Among the arguments people use when making such a decision is the fact that mortgage interest is tax-deductible, while credit card interest — usually much higher, climbing up to 30 percent in some instances — is not. In fact, long experience shows that making such a change is seldom a wise step.
Trading Unsecured Debt For Secured Debt
The most compelling reason you should not exchange mortgage debt for credit card debt is that you are converting unsecured debt (the credit card balances) for secured debt. A credit card company doesn’t ask for security, only your word that you will pay the debt. If you fail to pay, you could conceivably be sued, although most credit card companies don’t go to that extreme unless your balances are very large. The company could put a lien on your home, but typically it could not force you to sell.
With a mortgage, your house becomes collateral for the loan. The lender has a security interest in your home.
Loan Costs
Refinancing is not free. You’ll likely have to pay for an appraisal and possibly a home inspection, as well as loan origination fees and closing costs. The cost will depend on your credit score, your mortgage lender and the amount of the mortgage. In 2008, the Bankrate Survey determined that closing costs to refinance a $200,000 home amounted to an average $3,118. Those costs may to a degree offset the costs of high interest rates on credit cards.
Longer Time To Repay
Refinancing extends the time you will be obligated to discharge a mortgage (and the credit card debt you have added to the mortgage.) In reality, you are only extending the life of the credit card debt to the mortgage. That may mean it stays with you for the usual 15- to 30-year term of the mortgage. It is possible you will end up paying more interest than if you chose to plug along and pay off the credit card debt as you are able.
Credit Score Damage
A refinance may damage your credit score. It will trigger a new inquiry on your credit report by shortening the average or y our accounts. The companies that do credit reports will note the higher mortgage and be nervous, particularly if the level or your income is marginal. The impact may be short-term, especially as large-balance credit card debt will no longer show up in the reports, but there will be some impact.
Difficulties Selling Your Home
Selling your home may become more problematic if there are additional mortgages. To sell, you must pay off the balance of the mortgage burdens, and most likely pay a real estate commission of up to 6 percent. Banks typically won’t let you refinance a home unless the anticipated mortgage amount is below 80 percent of the home’s value. And be aware that home values tend to respond to financial vagaries and can fall fast. Having to sell under pressure because of such situations as a new job location might force you into missing the optimum return for your property.
Little Changes Made In Decreasing New Debt
Too many people who use a mortgage refinance to resolve credit card issues don’t overhaul their budgets and change their spending habits to avoid racking up more debt. They pile debt upon debt at an increased risk of losing their home because the mortgage payment is now higher and there are fewer options available. A genuine commitment to avoiding credit card debt is essential to getting any benefit from a refinance.
Solutions
Better alternatives for dealing with high-interest debt include debt settlement, debt consolidation and even bankruptcy. Putting your home at risk should be a last resort.
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