Refinance Debt

Should I refinance my mortgage to pay off my credit card debt?

Within the past two years, my income has decreased. I entered into a debt program to pay off credit cards. To date only one card has been satisfied. My credit score has been negatively impacted by financial status and I am currently experiencing difficulty paying my bills. Would like to know if refinancing mortgage to pay off debts would be viable option for us?

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Bill's Answer
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Updated: Sep 18, 2014

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Highlights

  • Take advantage of today's historically low refinance interest rates.
  • Start shopping for a home mortgage at the Bills savings center.
  • Complete a Form 1003 to start the home mortgage shopping process.

By historical standards, the fourth quarter of 2010 is an excellent time to shop for a new home mortgage or a home mortgage refinance due to the rock-bottom interest rates available to people with good to excellent credit. I see two options for refinancing your mortgage to pay off unsecured debt, or any other debt for that matter.

Option No. 1 provides immediate gratification at the expense of burdening your property with more debt, and potentially making the credit card debt far more expensive than the second option. Option No. 2 is a slower approach to resolving the debt, but does not burden your property with more debt, and will almost certainly be cheaper in the long run. Let us look at both options for refinancing your mortgage to pay off unrelated debt.

Option No. 1 exchanges one mortgage loan for another with a larger balance. This is known as a "cash-out" refinance. The advantages of a cash-out refinance is that the mortgage loan will almost certainly carry a lower interest rate than credit card debt, and is tax deductible. Paying off the credit card debt will result in a slight boost to your credit score.

There are significant disadvantages to using a cash-out refinance to retire other debt. Shifting unsecured debt to secured debt can create a volatile situation. If there is ever a chance that you cannot afford the new mortgage payment, you put yourself at risk of foreclosure. Mortgages are 30-year loans typically, which means that the total cost and the time to debt freedom could be very high. Of course, you could refinance to a 15-year loan that would have an even lower interest rate.

On the positive side, the monthly payment will be lower than making a mortgage payment plus the payment(s) for the other debt. The credit rating impact is neutral or positive.

Option No. 2 exchanges one mortgage loan with a presumably higher interest rate for a loan with a lower interest rate. Some homeowners will reset the loan term back to 30 years, and others will set the term at 15 years. The reason for refinancing to a lower term is to drive down the monthly payment. By driving down the monthly payment the homeowner frees cash flow for retiring the other debt. One tactic to consider is to refinance to a 30-year loan that does not have a penalty for early repayment. By refinancing to a low-rate, 30-year loan, the monthly mortgage payment will be as low as possible, which will allow the homeowner to devote the maximum amount of cash flow to retiring the high-interest debt. Once the high-interest debt is paid, the homeowner can increase the payment to the mortgage, and retire the mortgage in less than 30 years.

If you are ready to start shopping for a refinance now, go to the Bills.com mortgage refinance saving center to receive no-cost quotes from up to five pre-screened mortgage lenders.

Qualifying for a Refinance

Here are four things you need to be aware of when shopping for a mortgage or refinance.

1. Debt to Income Ratio

An important factor in qualifying for a mortgage or refinance is your debt-to-income ratio, which is called DTI in the trade. Your DTI is calculated by dividing your total income by certain debts you have, such as your principal and interest mortgage payment, property taxes, and homeowners insurance (PITI); any credit card or unsecured debt payments; student loan payments, and any vehicle payments. If the monthly payments for those debts take up more than 45% of your income, you will not qualify for a loan. See DTI: Debt-to-Income Ratio Information to learn more about calculating your debt-to-income ratio.

2. Two Years Work Experience

In general, lenders require that anyone on the loan has two been at the same job or working in the same industry for the past two years to have that income included in the qualifying income for a loan.

3. Loan to Value

Your loan-to-value (LTV) is another important component for qualifying for a loan. Your LTV is calculated by taking the current market value of your home (what you can sell it for in todayÂ’s market) and dividing it by the balance on your mortgage or mortgages. Do not use the value that the property tax assessor has assigned to your property, as it does not necessarily reflect the price you would get if you were to sell your home today. The higher the LTV, the harder it is to refinance. Some lenders will not refinance a loan if your LTV is above 90%, others even lower. There are some loans available through what is called Refi Plus that go up to 105% of your LTV, if your loan is serviced by Fannie Mae or Freddie Mac. You can find information here about the Refi Plus program.

4. Credit Score

Lenders use your credit score as an important factor in determining if you will qualify for a mortgage and if so, whether you will qualify for the lowest rates available. Everyone should keep track of his/her credit score, because it will have an effect on home loans, car loans, chances to get personal loans or credit cards, landlords for judging the suitability of a prospective tenant, and even can be used by employers in evaluating job-seekers. If you check your credit score now, you can see where it is now and work on building your score, if necessary, in case refinancing or purchasing another home is something you want to do in the future. For general information about credit, please review the information you will find at the Bills.com credit resources page.

Next Steps

An appraisal is necessary for a mortgage or a refinance to determine the market value of the property. An appraisal usually costs $350. For an unofficial estimate of your property's value, go to Zillow.com

This is written in late 2010. The last three years have been brutal for housing values across the US. Some areas have seen market values fall 50%, where other areas have dipped 15%. If the value of the properties in your neighborhood have held steady the last 12 months, you may be in a situation where the appraised value on your property may be the same as it was when you purchased it.

You will qualify for a home mortgage refinance loan if you have a steady, adequate income, your DTI is 35% or less, and the market values in your neighborhood have held steady. Download a Uniform Residential Loan Application (Form 1003), complete it, and start your home mortgage refinance shopping. Then, go to the Bills.com mortgage refinance saving center for no-cost, pre-screened quotes from home mortgage refinance lenders.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com