Paying Off Debt Through Refinancing
A client recently asked the following question:
“I have lots of debt that is building up more and more each month (falling behind). I am considering a refinance loan, as long as it is a low fixed rate, to a 40 yr mortgage. I currently have a 30 (paid 5 into it) and have a home equity. Is this a good idea? Should I consider taking extra to pay off other debt?”
Paying off debt by refinancing your home is almost NEVER a good idea, especially in an economic downturn. By increasing the amount of the mortgage, and therefore the monthly payment, you are placing your most valuable asset at risk.
Let’s say you have $25,000 of debt to include in the refinance. What happens if you lose a job or become ill and are out of work for a period of time? The potential of losing the home to foreclosure is $25,000 GREATER than if the debt had not been included in the mortgage.
Another consideration: Will you really save dollars by paying off the debt through the refinance? Almost certainly, no! Paying the debt over 30-40 years, even at the fairly low annual percentage rates for most mortgages, will more than triple the actual debt balance. That $25,000 will cost $75,000 or more over the life of the loan.
Many times each month I am contacted by clients who have used the refinance “strategy” to pay off their debt to no avail. In fact, their position has become worse after the refinance. Why? Simply stated, they have not learned to live within their budget, so they continue to accrue credit cards and other unsecured debt. Often, just months after refinancing to the higher mortgage and paying off their debt, they have generated new debt equal to or more than what they originally owed!
There is an old saying- “you can’t borrow your way out of debt.” And trying to do so by using your home as collateral is almost NEVER a smart move! Contact a certified credit counselor at 1-888-282-5899 to learn about other options to help you with your debt.
Published Apr 25, 2008.