Should I Pay Off Credit Cards Before Refinancing? A Comprehensive Guide

If you’re a homeowner having trouble paying off credit card debt, you might be ignoring one of your most important tools: your mortgage. Under the right circumstances, refinancing your mortgage can help you leverage home equity to consolidate credit card debt. However, the process is not without risks.

Let’s face it, credit card debt can feel like a heavy weight around your neck. It can be tempting to explore any and all options to get rid of it, and refinancing your mortgage might seem like a quick fix. But before you jump into a cash-out refinance, let’s take a deep dive into the pros and cons to see if it’s truly the right move for you.

The Allure of a Cash-Out Refinance

With a cash-out refinance, your existing mortgage is essentially replaced with a larger one. This enables you to take advantage of your home’s equity and use the additional funds to settle your bothersome credit card debt. It sounds good, doesn’t it? Well, hang on to your hats, because there are some unpleasant surprises ahead.

The Pros of Paying Off Credit Cards with a Refinance

Lower Interest Rates: Credit cards typically sport sky-high interest rates, often exceeding 20%. Mortgages, on the other hand, boast much lower rates, sometimes as low as 3%. This means refinancing could translate to significant interest savings over time.
Simplified Debt Management: Juggling multiple credit card payments can be a logistical nightmare. By consolidating your debt into one mortgage payment, you can simplify your financial life and avoid late fees.
Improved Credit Score: High credit card balances can negatively impact your credit score. Paying them off with a refinance can lower your credit utilization ratio (the amount of credit you’re using compared to your total available credit), potentially boosting your score.
Potentially Better Loan Terms: If your financial situation has improved since you first took out your mortgage, refinancing could land you a lower interest rate or a more favorable loan term.

The Cons of Paying Off Credit Cards with a Refinance

Reduced Home Equity: A cash-out refinance essentially diminishes your home equity, which is the portion of your home that you actually own. This can limit your financial flexibility in the future.
Longer Loan Term: Refinancing often means extending your loan term, which translates to paying interest for a longer period. This could negate some of the interest savings you might achieve.
Closing Costs: Refinancing comes with closing costs, which can be a significant expense. These costs can range from 3% to 6% of your loan amount, adding to your overall debt.
Potential Prepayment Penalty: Your existing mortgage might have a prepayment penalty, which means you’ll have to pay a fee if you pay it off early. This could eat into the financial benefits of refinancing.

So, Should You Do It?

The choice to pay off credit card debt with a cash-out refinance is a personal one. There’s no one-size-fits-all answer. Here are some key factors to consider:

The amount of your credit card debt: If your credit card debt is substantial, a cash-out refinance might make sense. However, if it’s a relatively small amount, other debt consolidation options might be more suitable.
Your home equity: You’ll need enough home equity to cover your credit card debt and still have some left over. Aim for at least 20% equity.
Your credit score: A good credit score will qualify you for better loan terms and lower interest rates.
Your financial situation: Ensure you can comfortably afford the new mortgage payments.

Alternatives to Consider

If a cash-out refinance doesn’t seem like the right fit, don’t fret. There are other ways to tackle your credit card debt:

Debt consolidation loan: This involves taking out a personal loan with a lower interest rate than your credit cards and using it to pay them off.
Balance transfer credit card: Transfer your balances to a card with a 0% introductory APR, giving you a grace period to pay off the debt interest-free.
Debt management plan: Work with a credit counseling agency to create a repayment plan with your creditors.

The Bottom Line

Paying off credit card debt with a cash-out refinance can be a smart move, but it’s crucial to weigh the pros and cons carefully. Consider your financial situation, explore alternative options, and talk to a financial advisor before making a decision Remember, the goal is to find a solution that helps you achieve long-term financial stability

How refinancing your mortgage can help consolidate debt

Consolidation loans are a common method of paying off credit card debt because they combine previous debts into a single new loan. Consolidation usually aims to secure a new loan with a lower interest rate, thus reducing the cost of the repayment process. It also allows you to combine multiple loan payments, usually to different lenders, into a single payment.

Another option available to homeowners is a cash-out refinance. With this kind of consolidation, you can borrow the same amount as you did for your previous mortgage plus any or all of your equity in your house. Your home equity is the difference between your homes value and your mortgage balance. In short, its the portion of your home that you actually own.

When you refinance with a cash-out, the majority of the new loan will be used to pay off your previous mortgage. Youll receive the remainder in cash, which will then be used to pay down your credit card debt.

Mortgages usually have far lower interest rates than credit cards, even though the principal on your new mortgage will be higher than it was on your previous loan. Therefore, over time, you may save a significant amount of interest by using your mortgage to pay off high-interest credit card debt.

Remember that refinancing is not available for every borrower and often comes with additional fees. Therefore, this type of debt consolidation is usually only a viable choice if you have a significant amount of credit card debt (think thousands, not hundreds of thousands of dollars). You also need to have acquired enough equity in your house to pay off your combined credit card debt in order for a cash-out refinance to be worthwhile in terms of time, money, and risk.

How refinancing a mortgage works

Refinancing involves taking out a new mortgage and using the proceeds to settle your previous loan. Ideally, your new mortgage features lower interest rates or improved loan terms. In this sense, by modifying the interest rates or monthly loan payments associated with your current loan, refinancing your mortgage may help you save money.

However, refinancing is not the right solution for every homeowner. First, not everyone will qualify for refinancing. A lender will review your application and your entire financial profile, including your income, credit history, and loan-to-value ratio (a ratio that shows how much you owe on your mortgage compared to the value of your property). Lenders have different criteria for approval. But generally speaking, they are more likely to approve borrowers who have a regular income, home equity between 2010 and 2020 percent of the value of their homes, and credit scores of 625 or higher.

Its also important to consider the cost of a refinance, which can be significant. The fees alone can amount to between 3% and 6% of your outstanding principal. Prepayment penalties for early repayment of your previous home loan may also apply to your mortgage.

Should I Move Credit Card Debt To A Personal Loan?

FAQ

Should I pay off credit cards before getting a mortgage?

Should you pay off a credit card before applying for a mortgage? “It does make sense to pay credit cards down or pay them off, then apply for a mortgage when your score is as high as possible,” Mendoza said. By decreasing your credit utilization ratio, you use less of your available credit.

What should you not do when refinancing?

Refinancing too often or leveraging too much home equity Avoid making the mistake of refinancing excessively to land a low interest rate. The charges to refinance repeatedly could add up over time, negating the benefits. Be wary of also leveraging home equity too often.

Should I refinance my mortgage to pay off credit card debt?

Although the principal on your new mortgage will be higher than your original loan, mortgages typically have far lower interest rates than credit cards do. So, using your mortgage to pay off high-interest credit card debt may lead to serious interest savings over time.

Should I pay off credit cards before refinancing car?

Since your credit card likely charges higher interest rates than your car loan, it’s a good idea to pay off your credit card debt first.

Can a cash-out refinance pay off credit card debt?

Using a cash-out refinance to pay off credit card debt is also known as a debt consolidation refinance. You end up owing the same amount, but you pay off high-interest credit card debt and replace it with lower-interest mortgage debt. » MORE: Shop current cash-out refinance rates Get personalized rates.

Can a cash-out refinance help consolidate credit card debt?

Consolidating credit card debt using a cash-out refinance allows you to make fixed payments over a set period, rather than paying a revolving balance every month. As a bonus, mortgage rates are usually lower than credit card interest rates.

Should you refinance your mortgage if you’re struggling to pay off credit card debt?

If you’re a homeowner struggling to pay off credit card debt, you may be overlooking a powerful tool — your mortgage. Under the right circumstances, refinancing your mortgage can help you leverage home equity to consolidate credit card debt. However, the process is not without risks.

Should I refinance to pay off my debt?

Likelihood you will accrue new debt: Refinancing to pay off your debt isn’t a great idea unless you have a plan in place to avoid new debt from building up in the future. Having zeroed-out credit cards can increase the temptation to spend, and it can take some serious planning to avoid ending up right back where you started.