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Refinancing a Mortgage to Pay Off Debt


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TERMINOLOGY

Refinancing a mortgage in order to pay off debt is a common strategy. Many homeowners use the equity in their homes to pay down other debts. This can be a smart move, but it also can be a financial disaster if done incorrectly or without discipline. The homeowner needs to be aware of the risks and understand the pros and cons of consolidating debt with a mortgage refinance.

Pros

There are some good points to paying off other debt by refinancing a mortgage. One is that usually a mortgage has a lower interest rate than other debt. If you have a car loan or credit card debt, the interest rates could easily be twice that of your mortgage rate. By refinancing and consolidating debt, you will see immediate monthly savings in your payments. Another pro is that you will eliminate multiple bills. It can be confusing trying to pay several credit cards and car loans that are all due on a different day of the month. If you consolidate, you will need to pay only one bill every month, which is your mortgage. One of the biggest pros is the tax benefit. Mortgage interest is tax deductible. So are certain fees involved with the closing, like prepaid points. By consolidating your debt, you are taking mounds of debt that are not tax deductible and rolling them into a debt that is tax deductible. You will see significant savings in your tax returns, especially if you have a large amount of debt.

Cons

There are cons to refinancing your mortgage in order to pay off debt. One is the possibility of overspending. If you have large amounts of credit card debt because of buying things you can't afford, then you will likely pay the cards off in the refinance and charge them back up down the road. You will feel that you are no longer in debt, when in reality, you just transferred the debt to another loan. So you must have discipline in order to prevent this situation. Another downside to consolidating your debt is that you are spreading the debt out over 30 years. A typical mortgage is 30 years long, and when you add that debt to your mortgage, you will be paying those credit cards for 30 years to come. This means that in the end, you will have paid more than if you paid each credit card on its own. And lastly, a big negative to consolidating debt into a mortgage is the possibility of a foreclosure. If you increase your loan amount, you may be unable to afford the new payment. You have now tied your debt to your home, which could have a bad outcome in the future.