With astronomical interest rates and high fees, credit card balances can rapidly snowball and become a significant problem, and that’s just within a few months. In order to get out from this lousy credit card situation, some individuals often take equity from their house through refinancing and utilize the money to payoff their credit card balances.
To those people, it looks like a fast and somewhat effortless solution. Just take money from your mortgage, an easy loan that generally comes along with tax-deductible costs and a lower interest rate, and eliminates your high interest credit card balances.
Refinancing your home to pay off your credit card debt may sound like a tempting option. However it is important to consider its advantages and disadvantages.
The Advantages of paying off your credit card loan through home refinancing
Reduction in Interest Rate
Currently, average mortgage interest rates are below 5% while average credit card rates sitting around 15%, you can immediately see where the savings are by taking equity of your home to pay off your credit cards.
Taking an example from NerdWallet:
On a credit card balance of $30,000 at an interest rate of 14.9% APR with making minimum payments, it’ll take over 40 years to settle your credit card balance, and you’d also pay more than $48,000 in interest.
If you convert that same credit card loan into a fixed mortgage of 30 years at an interest rate of 5%, you’ll not only have a lower monthly payment but would also have to pay less than $28,000 in interest.
Mortgage interest is tax-deductible if you choose to itemize your taxes. On the other hand, credit card interest is not tax-deductible even though it’s often much higher. This tax deduction is usually minimal for an average homeowner; however, as a pro, we’ll chalk this up as a pro.
Increase in Credit Score
Your credit utilization ratio is likely to be higher than the recommended 30% in case your credits cards are maxed out (your balances divided by credit limits). Therefore you could provide your credit score with a much-required boost by paying them off in full.
The Disadvantages of paying off your credit card loan through home refinancing
You might be thinking that settling your credit card via refinancing your house is one of the fastest and easiest ways to save money; however, it’s not often the case as things are not this simple.
When you refinance, you’ll incur closing costs and these costs can range between 3 to 5 percent of the entire loan amount. Additionally, if you increase the total amount owed on your house to over 80%, you are at risk of your mortgage refinance application being denied.
As these costs can rapidly add up, it’s important to ensure that you fully understand when you’ll save money with refinancing and when it’s a better option to continue paying the minimum payments on your credit cards.
It Makes Your Home Harder Sell
There is an excellent point made by personal finance blog MoneyCrashers that one another possibly overlooked problem of refinancing to settle your credit cards is that there is a chance that it would become much hard to sell your home in near future.
“When you refinance and make your mortgage larger, you create a situation in which it’s difficult to entertain offers below your current mortgage amount. This is why banks typically won’t let you refinance a home unless you can keep your total mortgage amount below 80% of the value of the home. However, even this situation is risky – property values could fall precipitously, or you may need to sell your house quickly due to a variety of circumstances, such as job relocation.”- From MoneyCrashers Blog
Every person’s circumstances are different from one another, so it’s essential to determine all the advantages and disadvantages by utilizing your numbers and scenarios. Only after that, you will be truly able to determine whether refinancing your house to pay off your credit card loan is the right choice for you.
Assess and weigh all of your loan options and try to find the best one that will suit best for your overall requirements. Visit our website www.lendova.com for further information.