Should Your Move Debt to Your Mortgage?

Learn when it makes sense to shift high-interest debt to your mortgage by refinancing.
By Richard Barrington

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Refinancing your mortgage loan can help make your debts more manageable — and it can also increase your risk of losing your home to foreclosure. Any time you use your home as a security for a loan, you are essentially betting your house on your ability to repay.

Mortgage debt has certain advantages over other forms of debt. It typically carries a lower interest rate, and that interest is often tax-deductible. So, in theory it makes sense to funnel as much of your debt burden as possible into a mortgage, which you can accomplish by refinancing. The catch is that this debt is secured by your home, so you only want to ramp up mortgage debt if you are absolutely certain of being able to keep up with the payments.

Making the call

Americans have effectively been trading mortgage debt for more expensive forms of borrowing in recent years. Consumers have paid off a trillion dollars in mortgage debt since 2009, but since that time they have also accumulated another half a trillion in other forms of debt. In at least some of those situations, people probably would have been better off choosing the cheaper mortgage debt over more expensive borrowing, such as credit card debt and personal loans.

Here are some examples of when it does and does not make sense to increase your mortgage debt while refinancing:

  1. If you are having trouble making your monthly mortgage payments, refinancing can help. If you are a few years into a mortgage and struggling to make your monthly payments, refinancing into a new 30-year mortgage will spread your remaining balance out more and make your payments more manageable (assuming mortgage rates have not risen significantly). Stretching your loan out will probably mean paying more interest over the life of the loan, but that’s a better alternative than foreclosure.
  2. Refinancing should not be a gateway to more spending. Spreading your debt out in the manner described above can be a necessary evil, but it should not be used to free up money in your budget for more spending.
  3. Cash-out refinancing can be used to reinvest in your home. Tapping into equity makes sense if you are reinvesting in necessary maintenance and repairs, or in improvements that will add value to the home.
  4. Trading equity for discretionary spending is a bad idea. On the other hand, you should not sacrifice equity for luxuries you don’t really need, like a vacation or new television.
  5. A mortgage can be used to retire high-interest credit card debt. Credit card interest rates are about 8 percentage points higher than mortgage rates today, so if you can use a cash-out refinancing or home-equity loan to retire some credit card debt, you could save a bundle on interest expenses.
  6. Shifting debt to a mortgage only makes sense if you are confident you can repay it. The above strategy only makes sense if it won’t make your mortgage payments unmanageable and put you at the risk of default. It also should be used as a one-time way to retire credit card debt, not as a way to refuel those cards for more borrowing.

Ultimately, refinancing is like most financial tools — it is neither inherently good nor bad, and the wisdom of using it depends entirely on how and why you do it.

Frequently Asked Questions

Q: We are having a hard time keeping up with our credit card debt, but we do have a fair amount of equity in our home. Is it a good idea to do a cash-out refinancing so we can use some of that equity to pay off our credit card debt?

A: There are a couple of good arguments in favor of your idea, but their are also some serious cautions to consider before you go ahead.

The arguments in favor:

  1. You’ll save money on interest. According to the Federal Reserve, the average rate being charged on credit cards these days is a little more than 13 percent. Current mortgage rates are about a third of that, so you could certainly save some interest expense by exchanging your credit card debt for mortgage debt.
  2. It will help you avoid credit trouble. Debt often becomes a vicious cycle: People have trouble making payments, so their credit rating goes down. People with lower credit ratings have to pay higher interest rates, which makes their debt more expensive and their payments that much harder to make. Tapping into home equity may help you break this cycle.

Here are three cautions:

  1. A home-equity loan may beat cash-out refinancing. The choice between these products depends on how today’s refinance rates compare to your existing mortgage rate. If current mortgage rates are cheaper than your existing mortgage rate, then a cash-out refinancing could be a way of killing two birds with one stone: accessing some home equity while lowering the interest rate on your existing mortgage debt. However, if you can’t get a refinance rate that’s better than your existing mortgage rate, why not just use a home-equity loan to borrow what you need to pay off credit card debt, while leaving the lower rate on your current mortgage intact?
  2. You could be setting yourself up for the same trouble again. Whether you refinance or use a home-equity loan, see what your new mortgage payments would be, given current mortgage rates and the additional debt you would be taking on. Then, see if you can create a budget around these payments that does not involve running up further debts. Otherwise, you will just be back in the same boat some time in the future, only without that home equity to bail you out next time.
  3. Your home may now be on the line. Defaulting on any debt is serious, but risking losing your home is especially dangerous. This is another reason careful budgeting is important before you refinance. If you are simply exchanging credit card payments you are having trouble meeting for mortgage payments you would have trouble meeting, then using home equity to pay off credit card debt is a bad idea.

In short, tapping into home equity to pay off credit card debt may make sense, provided you don’t just use it as a temporary way to get out of a hole, but as part of a plan to get out of the hole and stay out.

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Richard Barrington