When to Use a Home Refi to Pay Off Credit Card Debt
Homeowners with large credit card balances find themselves frustrated with the interest and fees they are paying each month. And rightfully so — the average interest rates on variable rate credit cards is currently hovering around 15% per year. It is not uncommon to see credit card rates as high as 30% or even 35% per year. Because of this, homeowners may consider a home refinance (Home Refi) as a way to pay off high interest credit card debt with a low interest mortgage loan. Is a home refi right for you?
Some people will tell you that a home refi is a no-brainer in a situation like this. Substituting 15% interest on a credit card for 6.4% interest on a mortgage does sound enticing. But the situation is more complicated than it sounds. Before agreeing to a home refi, it is important to analyze your situation and consider the pros and cons.
- Lower Interest Rate. As discussed above, a home refi will almost certainly lower the interest you are paying. Average annual interest rates on 30 fixed mortgages currently stand at approximately 6.4%. If you have $20,000 in credit card debt, the difference between a 15% interest rate and a 6.4% interest rate will be more than $140 per month.
- Interest is Tax Deductible. Mortgage interest is usually tax deductible, while credit card interest is not. What this means is that a home refi will not only lower the interest you are paying, but also lower your tax burden. Depending on your tax bracket, it could mean that a 6.4% mortgage interest rate is equivalent to a 4.1% after-tax credit card interest rate.
- One Simple Payment. One of the nice benefits of consolidation through a home refi is that you pay off all of your different credit cards, allowing you to make only one fixed mortgage payment each month.
This is much easier to manage than multiple credit cards and mortgage payments with different due dates and changing payment amounts.
- Putting Your Home at Risk. Credit cards are unsecured debts. This means that your property cannot be repossessed or foreclosed if you fail to make payments. This is also one of the reasons that interest rates on credit cards are so high. Be aware that if you get a home refi to pay off your credit cards, you are taking unsecured debts and making them secured by your home. If an unexpected event happens that makes you unable to pay your credit card bills, your credit rating will suffer. But if that event means you can't make your mortgage payment, you could lose your home. Make sure to do a detailed budget to make sure that you have some financial breathing room so that even in the event of an unexpected hardship (medical, temporary job loss) you will be able to continue making your increased mortgage payment.
- PMI May Cost You. Be aware that if your home refi increases your mortgage balance about 80 percent of the value of your home, your lender will require you to pay for Private Mortgage Insurance (PMI). This could increase your monthly payment by $100 to $200 per month (it is not tax deductible) and wipe out the benefit of your lower interest rate.
- Mortgage Fees and Total Interest Paid may be Higher. Be aware that if you have the ability to pay off your credit debts in a short time period, you will almost always be better off paying off your credit card debt versus getting a home refi. First, there are significant fees that you will pay to the mortgage company that is refinancing your home — these could total 2% or more of the mortgage balance you are refinancing. In addition, if you could pay off your credit card debt in a short period of time, the total interest you will pay on that debt could be substantially less than the interest on a 6.4% mortgage that is paid out over 30 years. Paying $20,000 in credit card debt at 15% over 4 years will result in total interest to you of about $6,700. Paying $20,000 at 6.4% over 30 years in a mortgage will result in about $25,000 in interest.
- Avoid the Trap of Running up Cards Again. If you do decide on a home refi to consolidate your debt, be sure to avoid the common trap that many people fall into — running the balances on your credit cards right back up again! Consider cutting up your cards, with the exception of one small balance card for emergencies only.
A home refi can be a good way to pay off your credit cards and lower the interest rate on your debts. However, it is not the "no-brainer" some people claim it to be. Analyze your situation, your personal budget and the pros and cons before taking the financial leap.