Hi Scott,

I have a 30-year home mortgage and $14,000 in credit card debt. My mortgage has 28 years to go to pay off and is at 5.875 percent. My credit cards are at 3.99 percent for the lifetime of balance to 10.9 percent--all fixed rates. Should I refinance my home with cash-out to pay the credit cards off then freeze them? I'm 57 years old and earn approximately $26,000 per year salary. Any advice for me?

Lynda

This is a common, and complicated, dilemma. Do you refinance your home to pay off debt and take on a bigger mortgage, or keep currents debts and pay non-deductible interest to the credit card banks?

There are many issues to keep in mind when making this decision. The place I begin when taking on this question is cost. You need to ask yourself, “Which choice will save me the most money?” That question needs to guide your decision. After all, why would you want to pick a loan option that costs more money? You wouldn’t.

However, many people want to refinance their mortgage to use the cash-out to pay for credit card debt with the goal of reducing monthly payments and thus, increase cash flow. Of course, that comes with a price if the new mortgage costs more than current loan terms.

The next, but overriding, question that needs to be answered is: “Should I change my unsecured debt into secured debt by refinancing my mortgage?” If you’re having major financial problems and are considering a possible bankruptcy, then I would stay away from rolling my credit cards into a new mortgage. Of course, if you’re having trouble, you may not be able to get the new mortgage anyway. The bottom line for this question is that if you feel that you may be heading for bankruptcy, then you should consult a bankruptcy attorney about your options before doing any type of refinancing.

Analyzing the costs of the mortgage is the primary way to assess a cash-out situation. One piece of information required is your tax bracket. Let’s say that Lynda’s tax bracket is around 12 percent. That means her interest costs, after deductions related to a new mortgage, will be 88 percent of the rate for non-deductible interest. For example, if her credit cards are charging 8.8 percent, then Lynda needs a second mortgage of 10 percent or less to beat the card rates because 8.8 is 88 percent of 10.

The next big challenge is going to be guessing at possible refinance interest rates. Additionally, closing costs associated with a new mortgage will play a factor in determining the rate. For the purposes of this discussion, the interest rate of the new mortgages will include all closing fees. That said, any mortgage greater than her current rate of 5.875 percent will cost more because it will increase the cost of the larger balance, which most certainly is the first mortgage.

Let’s assume that the new mortgage rate is exactly the same as the current rate of 5.875 percent. This means no increased cost on the mortgage balance--good! But what about the credit card debt? Well, by using the 88 percent rule, all credit cards that are less than 5.17 percent should stay as credit card debt because they cost less than the new mortgage. Specifically, the 3.99 percent for life deal is great and will beat the new mortgage. In fact, that rate would beat a new mortgage at 4.53 percent!

So the answer to the question is that this is a balancing act between cash flow, ability to get a better rate on a new mortgage, and one’s financial situation regarding converting unsecured debts to secured debts. For me, the clear choice is always the one that brings me the most savings. I want to keep every dollar possible and use it to pay off high-rate debt. Of course, you need the cash flow to do this, but how much cash flow can you create?

Even if Lynda refinances the entire $14,000 for 30 years at 6 percent, her payments are around $85. The minimum payments on her credit cards right now are probably $280.00. So at best, she’d create a positive cash flow of $200 month. Not bad. Now, if that can be done, and money saved, then it’s a perfect win-win situation.