Is Including Credit Card Debt in Mortgage Refinancing Smart?

by Ciaran John

When you refinance your home, you can often take out some equity and use it to pay down your credit card debt. When you do so, you simplify your monthly budget by replacing several bills with one, and you can potentially save money. However, there are both advantages and disadvantages to paying off credit card debt with a mortgage loan.

Default

Credit cards are unsecured, which means your lender has no claim on your home, your car or any other collateral if you default on the debt. Creditors' rights vary greatly among states but in many instances credit card companies have the right to garnish your paycheck or bank account in order to collect past due debts. If you pay off your credit cards with a home loan, your home is on the line if you ever fall behind on your payments. On the other hand, you may feel less likely to run into financial problems if you replace multiple high-interest debts with one low-interest mortgage loan.

Interest

An absence of collateral means that credit cards are inherently riskier for lenders than home loans. Consequently, interest rates are much higher on credit cards and other types of unsecured debts than on refinance loans. You reduce your interest rates when you pay off your credit card debts with a home loan. However, you also convert an unsecured debt into one that you must pay for the next 15 or 30 years. Whether such a move makes sense depends on your own circumstances. For example, if you normally make interest-only payments on your credit card, a cash-out refinance may make sense because you can now pay off the principal you owe.

Credit Score

Your credit score is affected by many factors, including your average account balance. If you pay off your credit card debts but keep your cards open, you reduce your credit utilization ratio, and this improves your score. What's more, missed credit card payments hurt your credit score -- so replacing multiple payments with one easy-to-manage debt can also have a positive impact on your score. If your credit score rises, it's possible that you can borrow money more cheaply going forward, and pay a bit less on credit cards, car loans and even car insurance.

Other Considerations

If high balances on your credit cards have had an adverse impact on your credit score, you may pay a higher interest rate to refinance your home than you would if your credit were better. In that case, it may make more sense to pay down your cards and raise your score before exploring the refinance option. Regardless of your ability to afford a refinance loan, you can only pay off your credit card debt if you have sufficient equity in your home. The expense of closing costs could further reduce your equity and offset some of the financial benefit of paying off the credit card debt.

Photo Credits

  • Hemera Technologies/AbleStock.com/Getty Images