Unsecured credit card debt is a major issue for many Americans. If you have thousands of dollars of credit card debt and also a mortgage, auto loan and student loan, you can find yourself betting crunched for cash fast. In fact, the average household in America today has $15,000 or so of credit card debt, with an average interest rate of 15%. But many people pay higher rates than that. If you are one of the people with a lot of credit card debt, we recommend that you consider eliminating your debt with your home in some cases.
Below is more information about how to use home-ownership to eliminate debt.
Leverage Low Mortgage Rates to Your Benefit
You may have noticed in 2018 that interest rates on mortgages are still low in the range of 4%. Many experts are surprised that mortgage interest rates have stayed this low for this long. It is believed that rates will soon rise as the economy gets strong and inflation rises.
You can use these low interest rates to your advantage with a mortgage refinance. Let’s assume current mortgage interest rate is 4%. At least 10% separates the mortgage rate at present with the typical credit card interest rate of 15%. The rates on unsecured debt are always higher because the chance of default is higher.
But what if you can move the debt costing you 15% per year to your mortgage where you will pay a mere 4%? This could effectively save you 10% in interest every year.
With a first mortgage refinance with cash out, you can take the equity in your home and use it to pay for whatever you like. Many people use their equity from a cash out refinance to do a home remodel or pay off debt. They like to use the first mortgage refinance to pay for debt because it is a fixed rate, low interest loan. You know what you are going to be paying exactly year after year with a 30 year or 15 year fixed rate mortgage.
How to Do a Cash Out Refinance Right
If you think getting a cash out refinance is the way to reduce your debt, you first need to check that you have enough home equity. Most lenders will note let you have a loan to value of more than 80% after the refinance. If you were to exceed that ratio, you have to pay for private mortgage insurance. This will cost you about 1% of the amount of the loan every year.
To calculate what your LTV is, divide your current first mortgage balance by the rough value of your home. Let’s say your mortgage balance is $300,000 and you have a home that is worth $450,000. You want to pay off $15,000 of credit card debt. This means that you have a 70% LTV when you include your $15,000 of credit card debt. So, you should be able to do this loan if you choose to.
What Are the Downsides of a Cash Out Refinance?
When you do a cash out refinance to eliminate debt, you are boosting your mortgage balance by the amount of debt you paid off. This will possibly make your monthly mortgage payment go up, depending upon the new interest rate.
If you are deciding whether to do this, you should think about how many years you have left on the loan. If you have paid off several years from the loan, you may not want to make another 30-year mortgage. It may be better to get a 25 or 20-year term. The shorter term will lower the rate and save you a lot of interest. But it will give you a higher mortgage payment each month.
Also, taking on more debt on your home means you are putting your home on the line. If you are unable to make the mortgage payments for whatever reason, you can damage your credit and even lose your home.
Other Option to Eliminate Debt with Home Ownership
If you are satisfied with your current first mortgage interest rate, another option is to get a second mortgage. There are two types of second mortgages to consider:
- Home equity loan: This is a lump sum, fixed rate loan that you take out of the equity in your property. The rate will be higher than a first mortgage, but it is much lower than a credit card interest rate. This may be a good option if you have a big chunk of credit card debt to pay off and want a stable payment.
Your home is a good possible source of low interest cash if you need to pay off debt. Do so with caution because once you have increased the mortgage balance, you probably have a higher payment, and now your home is on the line.