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. Credit & Loans

    Getting Government Loans For Your Small Business

    Would a government loan provide a more cost-effective way to finance your business? See whether your company qualifies for a government loan.
  2. Budgeting

    10 Ways to Save Money at the Farmers' Market

    Strategic shopping can help your budget as well as your health.
  3. Savings

    6 Ways to Save Money on Back-to-School Stuff

    Those school-supply lists just keep getting longer each year. Here's how to shop smart.
  4. Credit & Loans

    Your Credit Score: More Important Than You Know

    Credit scores affect key aspects of your personal and professional life. Knowing your score and managing your credit input can make a big difference.
  5. Credit & Loans

    Joint Credit Cards: The Pros and Cons

    A joint credit card may sound like an easy way to split the bills, but make sure you know what you’re getting into first.
  6. Credit & Loans

    Schedule Loan Repayments with Excel Formulas

    Calculate all the particulars of a loan using Excel, and set up a schedule of repayment for a mortgage or any other loan.
  7. Personal Finance

    Simple Interest Loans: Do They Exist?

    Yes, they do. Here is what they are – and how to use them to your advantage.
  8. Credit & Loans

    Fixing Your Credit Score: A Do It Yourself Guide

    Following these five steps can go a long way toward repairing a low score.
  9. Insurance

    How to Shop for Home Insurance

    Tips for getting the best protection for your place and possessions.
  10. Personal Finance

    Sending Money: MoneyGram vs. Western Union

    Comparing the differences between the services – and the fees.
RELATED TERMS
  1. Zombie Foreclosure

    A situation (or a home in this situation) that occurs when a ...
  2. Regional Asset Liquidation Agreement ...

    An agreement between an asset manager and the Federal Deposit ...
  3. Accelerated Resolution Program ...

    A program designed to reduce the time and cost of resolving failed ...
  4. Linked Transfer Account

    Accounts held by an individual at a financial institution that ...
  5. Advance Dividend

    An estimate of the present value of an asset being liquidated ...
  6. Commercial Real Estate Loan

    definition of a commercial real estate loan
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. In the context of a bond, what does the principal refer to?

    The principal of a bond refers to its face value, or the actual amount listed on the bond itself. The bond's principal is ... Read Full Answer >>
  6. What are the similarities and differences between the savings and loan (S&L) crisis ...

    The savings and loan crisis and the subprime mortgage crisis both began with banks creating new profit centers following ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!