Should I Refinance My Mortgage to Get Rid of Credit Card Debt?
Taking on a new mortgage to get rid of credit card debt may seem extreme, but for some consumers in certain situations, it may actually pay off. Because mortgages generally have much lower interest rates than credit cards, you could save significant money in interest. However, this repayment method also has a few considerable drawbacks. For example, you'll have less equity (or ownership) in your home than you had previously.
Refinancing your mortgage to pay off credit card debt is a big decision and should only be considered if your debt reaches into the tens of thousands of dollars and is growing via interest every day. It's generally not a good solution for an amount, such as a few hundred or a thousand dollars, that you may be able to tackle with a long-term repayment effort. Before you make a decision one way or the other, it's important to know what you're getting into.
How refinancing a mortgage works
Refinancing a home loan involves paying off your current mortgage and replacing it with a new one.
The exact process of refinancing a mortgage depends heavily on state laws and regulations. However, generally, the process of refinancing will likely be similar to the experience you had with your first mortgage. To determine whether you qualify for refinancing, lenders will take into account various factors such as your credit scores, other debts, income, assets and the amount you want to borrow. They'll also consider how much your home is worth to determine the loan-to-value ratio.
Ideally, you should have a regular income and at least 10 to 20 percent equity in your home to qualify for refinancing. Credit scores of 740 or more (within a standard range of 300 to 850) will also generally help your chances, although borrowers with scores of 620 and up can get mortgages insured by the Federal Housing Administration (FHA) from an FHA-approved lender.
Refinancing also comes with some fees and other costs. You might pay 3 to 6 percent of the outstanding principal in fees. Depending on your lender, you might also owe a prepayment penalty for paying off your old mortgage early.
If you're looking to get rid of credit card debt, you can apply for "cash-out" refinancing, which allows you to tap into your home equity — or the difference between what you owe on your mortgage and the home's value. In this scenario, you'll refinance for more than you currently owe and get the difference as a cash payment.
Refinancing pros and cons
The main reason to go through with cash-out refinancing to pay off your credit card debts involves interest rates. The interest rates for credit cards can approach 30 percent. By contrast, mortgage interest rates today are generally much lower.
Paying off all of your credit card debt might also help your credit scores. However, some lenders might require that you close your credit card accounts after paying them off, which could harm your credit scores, particularly in the case of longstanding accounts that add to your credit history.
Consumers who refinance their mortgages to pay off credit cards can run into several potential pitfalls. For example, if you fail to change your spending habits, you might rack up more credit card debt on top of your new (likely higher) mortgage payments. Additionally, you will end up paying for the purchases that got you into trouble over a much longer period of time since they're now part of your mortgage. Further, cash-out refinancing leaves you with less equity, meaning you own less of your home.
Alternate ways to pay off credit card debt
Cash-out refinancing is not your only option for paying down credit card debt. For example, you could explore a home equity line of credit or a home equity loan. You could also negotiate with your credit card companies to secure lower interest rates or consolidate your debt with a balance transfer. Read more about balance transfers in our article on the subject.
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