A reader has tried everything else. Or has she?
Question: I’m carrying about $12,000 on nine credit and store cards, and the interest rates are killing me. I already rolled over the balances a couple times to low-interest and zero-interest cards, but I blew through the introductory offers. But I own my condo, and if I refinance it, I can probably cover what I owe. Should I refinance my home to pay off debt?
— Debby in New Jersey
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Tendayi Kapfidze answers…
There are several things to consider. Let’s start with the easiest and proceed from there.
On the surface, “should I refinance my home to pay off debt” is a simple question to answer. Interest rates on a home refinance are much lower than those on credit cards. Current rate are around five or six percent if you have good credit, versus the 17 or 18 percent average for credit cards. So taking a cash-out refinance to pay off the credit cards would certainly lower your interest costs.
What is a cash-out refinance?
This is a lending option available exclusively to homeowners who have equity in their homes that they wish to use. You essentially take a new mortgage for more than you currently owe, up to the full fair market value of your home. The money from the new loan is used to pay off your existing loan. Then you receive the difference in cash and can use those funds to do things like pay off credit card debt.
This can seem like a good option, but it’s not without its risks. By taking out a new loan at the fair market value of your home, you risk going underwater if there’s a turn in the economy. Basically, you’ll owe more than the home is actually worth. It also puts you at a higher risk of foreclosure. Your monthly payments will likely be higher and if you fall behind because you can’t afford the new payments, you could lose your home,
For this reason, most experts will usually recommend against a cash-out refinance if the sole purpose is to pay off debts like credit cards. It’s just not worth tapping the equity you have and increasing your foreclosure risk simply to get out of credit card debt.
Can you get an unsecured debt consolidation loan instead?
One alternative would be to get an unsecured personal loan for debt consolidation. Unsecured loans currently have rates from seven percent and up. That’s higher than the rate would be on the cash-out refinance, but it could still be lower than the credit card rate, depending on your credit profile.
If you still have good credit, this could be a good option, as long as you can get your budget balanced so you can stop making new charges on your credit cards. You’d get the loan and use the funds you receive to pay off all your credit card balances. This would leave only the fixed-rate loan for you to worry about.
Whatever solution you use, balance your budget first!
A particular concern, Debbie, is that you said you “blew through the introductory offers.” So you have already attempted to lower your interest cost, which was smart. However, for this strategy to be most effective, it’s important to not add new debt, but instead, work toward paying off the debt. With nine cards in total, it may be that you have been rolling over balances to new cards and then building up more debt on both the new and old cards. Hence, you are not making progress on lowering debt.
The same thing can happen with a consolidation loan or the cash-out refinance. You’ll pay off your credit cards with the money from the loan. But your credit cards will still be open and you may be tempted to run up new balances. So, the first thing you need to do is take control of your budget. Make a budget that balances all your bills and other expenses against your income. That way, you can stop charging and focus on paying off debt.
Finding the right loan
Nine accounts is a lot to juggle and you could benefit from a tool like myLendingTree. It’s an online lending tool that uses algorithms to suggest debt consolidation strategies. This could help you find the best options for your particular personal financial situation. There is also a wealth of educational material that will help you improve your credit score and learn better techniques for managing debt.
A second opinion on your situation…
Just to confirm my information, I asked my friend Matt Schulz about your situation. Matt is chief industry analyst at CompareCards.
“Plain and simple, you need to pay that card debt down,” he says. That’s because credit card APRs are as high as they’ve ever been, and they’re just going to go higher. “Zero-interest balance transfer cards are a great way to help knock that interest down, and even if you blow through the introductory periods and don’t pay the balance off in full, you’ve likely still saved yourself a fair amount of interest.”
Matt is also wary about refinancing your home, but he can see a scenario where it works.
“When you have $12,000 in debt, sometimes you need to make a big change,” he says. “If you do all the math and find that refinancing your home will free up a ton of money that you can use to pay down your credit card debt, then it’s certainly worth considering. A personal loan might be useful as well. Just make sure that you do your homework and know exactly what you’re getting into with either of these options, and that you understand all the fees and costs that come along with them. The last thing you want to do is make things worse on yourself because you made a rushed and uninformed choice.”
For further information read Debt.com’s education section on “Should I Refinance my My Mortgage?”
Tendayi Kapfidze is chief economist for LendingTree.
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Published by Debt.com, LLC