Home loans can be taken for more than you actually owe on your home, and the extra money can then be used to pay off other debts. For example, if you owe $80,000 on your home, you might borrow $100,000 and use the additional $20,000 to pay off credit cards. Cash-out refinancing, as this is called, has pros and cons, however.
When you use cash-out refinancing to pay off your credit cards, you aren't ditching the debt, but rather moving it from the credit cards to your mortgage. Because your home is security for the refinanced loan, the interest rate is typically lower than that for your credit cards. The new mortgage payment may also be lower than the total for your home and credit cards before the refinance. You'll also likely improve your credit scores by paying down maxed-out credit cards. Your tax bill may shrink as well because mortgage interest often is tax deductible.
Refinancing has some negatives, however. You'll pay a lower interest rate on your credit card debt, but you'll take longer to pay it off. You may also be adding years to your home loan payoff, as well. In addition, your original mortgage company may stick you with a fee for paying off the loan before the end of the term. You may be socked with fees for applications, title search and closing attorneys. You may also have to pay points, or fees imposed by the lender at loan origination. Shop around -- some lenders will pay closing costs, especially if you have good credit or a lot of equity in your home.
If you borrow more than 80 percent of the value of your home, you'll be stuck with paying private mortgage insurance each month. A home equity loan or line of credit could help you avoid PMI. For example, to borrow 85 percent of the value, you might refinance 80 percent with the primary loan and the additional 5 percent through the home equity line.
Refinancing isn't free from risk. If you lose your job and are unable to pay your credit card bills, you're unlikely to lose your home, but if you refinance that credit card debt into your mortgage and are unable to pay, you probably will. Also be careful about borrowing too much of your home's value. If the market drops, you could end up owing more than the house is worth.
Making the Decision
Much of the decision about whether to do a cash-out refinance depends on the math. When you add up all the costs, does the refinance save enough money to be worthwhile? Would cutting expenses to pay off credit cards over a five-or 10-year period be a reasonable alternative? Finally, if you refinance, will you be able to stay out of debt? While taking cash out might make sense once, beware of doing so repeatedly.
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