On the surface, refinancing a mortgage to consolidate other debts is a tempting option. However, there are potential drawbacks you need to account for in order to make refinancing and debt consolidation work for you.

The obvious appeal is that mortgage rates are usually lower than interest rates on other forms of debt. If you have equity in your home, refinancing can let you borrow against some of that equity to pay off other debts, such as credit card debt and personal loans. According to the Federal Reserve, when 30-year mortgage rates were at 4.20 percent recently, credit cards were being charged an average of 13.14 percent. So the potential to lower the interest rate on your debt is clear. In addition, debt consolidation can simplify your finances by replacing multiple payments with a single mortgage payment.

So what are the downsides of refinancing to consolidate debt? For one thing, it raises the stakes. While credit card debt and other obligations generally cannot result in any claims against your home, mortgage debt directly puts your house at risk. Another concern is that by converting relatively short-term consumer debt into mortgage debt, you could be lengthening the period of your indebtedness.

To help you focus on whether the benefits of refinancing to consolidate debt outweigh the potential problems, here is a checklist of issues you should examine:

  1. Have you looked at both 15-year and 30-year options? If you have a substantial amount of equity to work with, it probably means you are several years into your mortgage. If so, you should at least consider refinancing to a 15-year loan as a way of getting an even lower refinance rate.
  2. Have you factored in closing costs and prepayment penalties? The interest rate comparison is the most compelling part of refinancing, but you have to make sure there is enough of an interest rate gap to cover the costs involved in refinancing, including any prepayment penalties on your existing mortgage and other loans.
  3. Have you compared mortgage quotes? Just because refinance rates are generally lower than your existing interest rates, do not assume all refinance rates are the same. Shopping around for mortgage quotes can help you get the most out of this strategy.
  4. Can you readily meet the new payment schedule? Once you have figured out what the principal and terms of your new loan would be, take a good hard look at the payment schedule that would result, because this is where the risk is. It is generally safer to default on other forms of debt than on a mortgage, so make sure you are not jeopardizing your home by rolling other debts into your mortgage.
  5. Is the interest cost really cheaper? You may be lowering your interest rate, but you should check a full amortization schedule to make sure refinancing won't cost you more interest expense in the long run by lengthening your repayment period.
  6. Have you mastered your budget issues? Refinancing should not be a means of simply taking on more debt. It should be part of a broader strategy to help you live within your means.

The bottom line is that refinancing to consolidate debts can be a good idea; but like any financial technique, the idea is only as good as the numbers behind it.

Related Articles
  1. Savings

    How Parents Can Help Adult Children Buy a Home

    Owning a home isn't easy thanks to stringent lending standards. Thankfully, there's ways parents can help their kids buy a home.
  2. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  3. Retirement

    4 Ways to Boost the Amount You Save for Retirement

    Retirement can easily last more than twenty years, which means you have to save a lot. Thankfully, there are ways to enhance the amount you put away.
  4. Credit & Loans

    Adjustable Rate Mortgage: What Happens When Interest Rates Go Up

    Adjustable rate mortgages can save borrowers money, but they can't go into it blind. In order to benefit from an ARM, you have to understand how it works.
  5. Retirement

    How to Stretch Your Retirement Savings

    What does "nest egg" mean for your personal situation? Will you deplete it, or will you nurture it to generate income that lasts throughout retirement?
  6. Savings

    Paycheck to Paycheck? Start Saving This Way

    The steps are simple; the execution not so much. But if you take some action toward your goal every single day, you'll see tangible results pretty swiftly.
  7. Retirement

    4 Reasons To Collect Social Security Payments Now

    The longer you wait to collect social security, the more you'll gain. But for people ailing in health or who need income, delaying isn't the best option.
  8. Retirement

    Can You Retire In Spain With $200,000 of Savings?

    How far will a modest nest egg take you in Spain? Here's a look at the cost of retiring on the Costa del Sol, or in one of Spain's culturally rich cities.
  9. Investing

    The Enormous Long-Term Cost of Holding Cash

    We take a look into how investors are still being impacted by the memory of the tech bubble and the advent of the last financial crisis.
  10. Retirement

    How to Catch Up on Retirement Savings

    Lots of people nearing retirement don't have enough saved. Thankfully there is a host of ways to catch-up on saving, from working longer to saving more.
  1. Are mortgage rates negotiable?

    Mortgages are just as negotiable as any other product or service. Whether it's a new home purchase or refinancing of an existing ... Read Full Answer >>
  2. Are Sallie Mae loans considered federal loans?

    Sallie Mae is a private lender, so its direct loans are not federal loans. Basically, federal student loans consist of money ... Read Full Answer >>
  3. How does the trust maker transfer funds into a revocable trust?

    Once a revocable trust is created, a trust maker transfers funds or property into the trust by including them in a list with ... Read Full Answer >>
  4. Under what circumstances might a syndicated loan be arranged?

    Syndicated loans are almost always arranged for huge, complicated projects that involve major corporations or governments. ... Read Full Answer >>
  5. How risky is a syndicated loan for the lender?

    Syndicated loans are specifically designed to spread risk exposure among different lenders in a joint liability venture. ... Read Full Answer >>
  6. How do I calculate how much home equity I have?

    Even though it is normally assumed most people know their home equity, many are still confused about the topic. It is an ... Read Full Answer >>
Trading Center