So, are you drowning in high interest credit card debt and personal loans? Have you also built up good equity in your home? You may be thinking about taking advantage of today’s still low mortgage rates and refinancing to pay off your debt.
It’s a tempting idea. And sometimes that makes sense. But transferring high-interest unsecured debt on your mortgage can also have dire consequences.
So, before you start filling out the paperwork for a home equity loan or cash refinance, there are a few things to consider.
1. Are you ready to put your home in jeopardy?
First of all, you must understand the stakes of this strategy.
Right now, your high interest debt is probably unsecured. This means that creditors cannot easily take the property if you don’t make the payments. (This is, after all, one of the reasons the interest payments are so high!)
If you transfer that unsecured debt to a mortgage, home equity loan, or HELOC, you will be putting your home at risk. This decision will likely increase your monthly mortgage payment. And if you find yourself in a situation where you can’t pay, the bank can foreclose on your house.
Related: 5 factors to consider before using a HELOC for your emergency fund
Of course, this is not necessarily a deal breaker. Often times, your overall payments can drop dramatically when you use your mortgage to refinance your high interest debt. But it’s always the first thing to consider.
Unless you are well positioned in terms of income to handle those mortgage payments, avoid this option.
2. What is the real difference between interest paid?
Another consideration is how much the refinancing process Actually saves you.
At first glance, it looks like you are cutting your interest payments by half or more. After all, you are refinancing a debt of $ 15,000 with an 18% interest rate at a 4% interest rate.
Remember, when you transfer your debt to your mortgage, you will likely be making payments over a much longer period of time. This means that you could end up paying the same or more interest, even with a massive reduction in interest rates.
Here’s an example of how refinancing a high interest personal loan to a long-term home equity loan can work:
- Personal loan debt: $ 15,000 at 18% interest and a minimum monthly payment of $ 300
- Home equity loan: $ 15,000 at 4% interest for 30 years
Switching to a home equity loan will drastically reduce your monthly payment to around $ 72, according to this calculator. With the home equity loan, you will pay around $ 10,780 in interest. If you stick to the personal loan, this calculator says you’ll pay about $ 12,934 in interest.
So it’s better, isn’t it? Well, be sure to consider the next point before you make up your mind.
Related: Strategies to Pay Off Your Mortgage Earlier
3. What additional costs will you pay?
Whether you decide to refinance your home, open a HELOC, or take out a home equity loan, you will likely be required to pay upfront fees. The fees vary depending on the type of loan you are considering.
Resource: A guide to refinancing your mortgage
HELOCs generally have a higher interest rate than refinancing or taking out a home equity loan. But they also come with lower fees if you’re looking for the best deal.
Home equity loans and refinancing will both incur costs – often very similar to buying a home in the first place. Depending on the process, you could pay a few hundred to a few thousand dollars in fees to refinance your debt.
You can avoid these additional costs, or at least mitigate them, by shopping. Also, be aware that home equity loans and lines of credit can have lower fees, albeit higher interest rates, than if you decided to refinance with cash.
4. How much is your house worth?
Of course, knowing the value of your home versus what you owe it is important. When lenders are considering giving you a second mortgage or cash refinance, they will take a close look.
While you can sometimes get a first mortgage with less than 20% of the equity in the home, you probably won’t be able to get a second mortgage under these circumstances. In other words, if your house is worth $ 100,000 and you still owe $ 80,000, you’re out of luck.
Learn more: How much down payment do you need to buy a house?
Even if you to do Having enough equity in your home, leveraging it to refinance debt isn’t always the best option.
In fact, it was these situations that caused big problems for many homeowners before the last real estate crash. People have squeezed deep into their equity during a period of inflated house prices. When that bubble burst and house prices fell, they suddenly found themselves underwater on their homes.
This meant that they owed more than the actual value of their home.
Being underwater is difficult. This means that you probably can’t sell the house without paying to get out of your mortgage. And that even makes refinancing to get a lower rate difficult, if not impossible.
It can be hard to tell if you’re in a real estate bubble that’s about to burst. But it’s important to have an idea of ââreal estate prices and trends in your area before you decide to refinance. Confused about where property prices are going in your area? Check with a local real estate agent to get a feel for current trends.
Resource: 11 Little-Known Facts About Home Appraisals
5. Are you planning to move soon?
If you are thinking about moving in the next few years, it might be a bad idea to carry your debt off your mortgage. The closer you are to the move, the harder it will be to recoup your refinancing costs.
Calculators like this one can help you figure out how much you’ll save. If refinancing your debt with your mortgage saves you $ 10,000 over 15 years, great.
But what if you move out within two years and just paid $ 3,000 in closing costs? In this case, you are probably going to lose money rather than save it.
6. Are you going to go into debt again?
Finally, be sure to consider what got you into so much debt in the first place.
Perhaps you had an unexpected accident and were unable to work for a few months. If you had a good background in money management before this point, refinancing might make sense. Stick to your old habits and you will soon be in good shape again.
But if spending too much money on debt is a recurring problem, it might not be the way for you. Remember that transferring your unsecured debt to your home puts your home at risk. If you go into debt again because your habits haven’t changed, you’ll end up with a bigger mortgage payment. and heavy credit card debt.
Related: 23 powerful tips and tools to eliminate debt
Whether or not you should use your mortgage to refinance your debt depends entirely on the situation. When making a decision, be sure to check current mortgage rates on a website like Loan tree.com.
Sometimes this really makes sense as a way to save money and speed up your road to debt freedom. But sometimes it’ll just get you in more trouble than it’s worth.
Related: How I refinanced and reduced my student loans $ 41,000