Is a cash-out refinance a good option for debt consolidation? At least one financial expert thinks not. Don Taylor, a financial advice columnist for the Web site Bankrate.com, recently wrote about the dangers of taking credit card debt and turning it into mortgage debt. After all, credit card debt is an unsecured loan. It’s annoying, and it’s a financial drain. But when consumers fail to pay their credit card bills, they don’t run the risk of losing their homes. However, when they fail to pay their mortgage bills, the threat of losing their residences to foreclosure is a very real one. For this reason, Taylor writes, turning unsecured credit card debt into mortgage debt can be a dangerous method of debt consolidation. Taylor advises that consumers stay away from it.
How It Works
You can only use cash-out refinancing if you have enough equity in your home. For instance, if your home is worth $300,000 and you have a mortgage loan of $250,000, you have $50,000 worth of equity left over. If you refinance your mortgage loan, you can refinance up to the value of your home, $300,000. You then get the extra $50,000 to you in cash. You can use that cash to pay down your credit card bills. The upside of this is that your new mortgage loan will undoubtedly have a lower interest rate attached to it than will your credit card debt. In essence, you are replacing high-interest-rate debt with low-interest-rate debt. It’s a winning swap.
The Risks
However, like most financial transactions, a cash-out refinancing does come with certain risks. As Taylor explains on Bankrate.com, there’s a reason why people run up huge amounts of credit card debt. If they don’t address those reasons, and change their spending habits, they run the risk of simply running up huge sums of credit card debt again. If they do this, they’ll again have large amounts of credit card debt and an extra amount to pay back on their new larger mortgage loan. This, of course, is hardly an effective debt consolidation strategy.
Losing Their Homes
An even more serious risk, though, is the very real threat of foreclosure. Consumers who run up huge amounts of credit card debt are more likely to default on their debts. That includes mortgage debt. If these consumers turn their mortgage loans into larger ones in a cash-out effort of debt consolidation, they run the risk of not being able to make their mortgage payments. If they miss these, they don’t just suffer dings to their credit scores. No, their mortgage lender or bank might foreclose on their home. It’s a huge risk for consumers who haven’t addressed their underlying spending problems.