Should You Refinance to Pay Off Revolving Debt?
Are you really serious about reducing your debt? I mean really serious. We have posted before about the pain that this process yields. Things you used to enjoy as a family have been cut back, severely in some cases in order to free up more cash flow to apply to reducing your debt. So here is the question: If you have equity in your house, should you refinance to pull some of that equity to pay off the revolving debt? After all, in doing so, you would likely have much more cash to pay down other things and/or return the family to a more enjoyable state. This is a lovely question that yields a variety of opinions. So let's explore. Below are a few pros and cons of doing so, and you draw your conclusion. The below assumes you have enough equity to apply to some or all of your revolving debt, but that in doing so, you will have a minimum ( all though I would recommend much more) of 20% equity thereby side stepping required PMI Insurance. If any of you feel I have missed some advantages and disadvantages, then by all means, provide a comment on this post. The more information, the better…
Pros
In many cases you will be able to significantly, or completely wipe out your revolving debt freeing up that cash that you previously used as a minimum payment and applying that to other debt, including paying ahead on your new mortgage. Or, as we mentioned above, actually take the family out to dine once in a while.
In most cases, you will be able to deduct the interest on the debt now that it is rolled into your mortgage. Of course, always seek advice and comply with the IRS rules. This action effectively reduces your overall cost of the debt since the higher interest (see below) was not deductable.
In most cases, you will effectively be seriously reducing the interest rate on the debt in question by rolling it into a mortgage. Most of today's cards carry an interest rate in excess of 10%. Mortgage rates for those with good credit can be as low as 4.5% on a thirty year mortgage. Do the math. That could be a tremendous amount less in interest dollars paid, especially when you roll the above tax advantage into the equation. (But read on below). And remember, interest dollars paid do nothing to reduce your debt, so minimizing this is key.
Depending upon your specific circumstances, you may be able to achieve all of the above, while still reducing your mortgage payment monthly. If you are fortunate enough to be in this situation, this is win - win.
These are fairly compelling reasons in favor of refinancing and rolling your revolving debt into the new mortgage. However, let's look at the down side:
Cons
You could end up worse than you started. With a clean slate on your revolving debt, you need to exercise specific discipline not to go back and start charging on your cards. In the end, the temptation is real and millions of people give in to this temptation. And if you do so, your debt has now compounded. If there is any question on this, tear up your cards when you refi. (There will be another post on whether you should tear your cards up or not at a later date)
You will add to the mortgage balance of your house. OK. You have done it. The problem here is that now you owe another "x" thousand dollars on your home, equity which you gave away that you worked hard to get in the first place
You will likely extend the life of your loan on your home. Here, there are choices. When I discuss the options and the 'pros' section, under number 4 above, I am assuming you take out another 30 year loan. If you have equity that you are rolling into the mortgage, likely you have been paying for quite some time, and the amount of time left is much less than 30 years. But for this discussion, there are choices. You can take out a 15 year note, as an example. You can commit to pay ahead on the loan….so this is a separate discussion point in itself.
There is risk in the housing market regarding valuations. This is a significant and somewhat new risk that arose from the great recession. You now have to be careful on your house valuation. Above, I suggest keeping a minimum of 20% equity. Well, quite frankly, in some markets, this could be dangerous. And even though most will agree that the worst of home devaluations may be behind us, can we really depend on that? Really? I think we have entered a new era when it comes to many things economically, and this is one real important one. We are one major terrorist attack on our soil from having the potential of another meltdown financially. And if something like this ever did affect your home value, you could be left holding the default bag.
The overall amount of interest dollars you pay may rise. As with all house notes, the overall amount that you end of paying to interest over the life of the loan is extreme. Adding to your balance and starting the loan over may exaggerate that more. While you can argue the interest dollars reducing overall as we have pointed out above, if you simply stay the minimum mortgage payment course for the new loan, your actual dollars for that interest may rise. So you must do the math and see if the impact is acceptable to your particular financial standards and desires.
There could be impacts to your credit standing. This is a lesser concern, but do know the impacts that any considered movement in reshuffling your debt may have on your credit standing
We have discussed the advantages and disadvantages of rolling a revolving debt balance into a mortgage refinance. I will not make a recommendation here as that would not be prudent. Answering this really depends upon each individual situation. There are many considerations and much research that needs to be done before leaping off of the cliff.
The goal of this post was to give you some food for thought, organize your thoughts a bit, so you could make an informed decision on this subject where there are many 'expert' opinions. Good luck.
Pros
In many cases you will be able to significantly, or completely wipe out your revolving debt freeing up that cash that you previously used as a minimum payment and applying that to other debt, including paying ahead on your new mortgage. Or, as we mentioned above, actually take the family out to dine once in a while.
In most cases, you will be able to deduct the interest on the debt now that it is rolled into your mortgage. Of course, always seek advice and comply with the IRS rules. This action effectively reduces your overall cost of the debt since the higher interest (see below) was not deductable.
In most cases, you will effectively be seriously reducing the interest rate on the debt in question by rolling it into a mortgage. Most of today's cards carry an interest rate in excess of 10%. Mortgage rates for those with good credit can be as low as 4.5% on a thirty year mortgage. Do the math. That could be a tremendous amount less in interest dollars paid, especially when you roll the above tax advantage into the equation. (But read on below). And remember, interest dollars paid do nothing to reduce your debt, so minimizing this is key.
Depending upon your specific circumstances, you may be able to achieve all of the above, while still reducing your mortgage payment monthly. If you are fortunate enough to be in this situation, this is win - win.
These are fairly compelling reasons in favor of refinancing and rolling your revolving debt into the new mortgage. However, let's look at the down side:
Cons
You could end up worse than you started. With a clean slate on your revolving debt, you need to exercise specific discipline not to go back and start charging on your cards. In the end, the temptation is real and millions of people give in to this temptation. And if you do so, your debt has now compounded. If there is any question on this, tear up your cards when you refi. (There will be another post on whether you should tear your cards up or not at a later date)
You will add to the mortgage balance of your house. OK. You have done it. The problem here is that now you owe another "x" thousand dollars on your home, equity which you gave away that you worked hard to get in the first place
You will likely extend the life of your loan on your home. Here, there are choices. When I discuss the options and the 'pros' section, under number 4 above, I am assuming you take out another 30 year loan. If you have equity that you are rolling into the mortgage, likely you have been paying for quite some time, and the amount of time left is much less than 30 years. But for this discussion, there are choices. You can take out a 15 year note, as an example. You can commit to pay ahead on the loan….so this is a separate discussion point in itself.
There is risk in the housing market regarding valuations. This is a significant and somewhat new risk that arose from the great recession. You now have to be careful on your house valuation. Above, I suggest keeping a minimum of 20% equity. Well, quite frankly, in some markets, this could be dangerous. And even though most will agree that the worst of home devaluations may be behind us, can we really depend on that? Really? I think we have entered a new era when it comes to many things economically, and this is one real important one. We are one major terrorist attack on our soil from having the potential of another meltdown financially. And if something like this ever did affect your home value, you could be left holding the default bag.
The overall amount of interest dollars you pay may rise. As with all house notes, the overall amount that you end of paying to interest over the life of the loan is extreme. Adding to your balance and starting the loan over may exaggerate that more. While you can argue the interest dollars reducing overall as we have pointed out above, if you simply stay the minimum mortgage payment course for the new loan, your actual dollars for that interest may rise. So you must do the math and see if the impact is acceptable to your particular financial standards and desires.
There could be impacts to your credit standing. This is a lesser concern, but do know the impacts that any considered movement in reshuffling your debt may have on your credit standing
We have discussed the advantages and disadvantages of rolling a revolving debt balance into a mortgage refinance. I will not make a recommendation here as that would not be prudent. Answering this really depends upon each individual situation. There are many considerations and much research that needs to be done before leaping off of the cliff.
The goal of this post was to give you some food for thought, organize your thoughts a bit, so you could make an informed decision on this subject where there are many 'expert' opinions. Good luck.
