 Credit
card balances force debt restructuring
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 Dear
Dr. Don,
I'm presently working on refinancing my home so that I can take
some money out to pay off my credit cards that have interest rates
as high as 30 percent. One card has about $12,000 with interest
of 30 percent and the other has an $8,000 balance with an interest
rate of 20 percent.
The current interest rate on my home is 6 percent and the refinance
rate will be 8 percent, since my credit rating is not that good
due to the high balances on my cards. This will increase my monthly
mortgage payment by 25 percent. The loan balance on my house is
about $300,000. The house should appraise for about $495,000 and
I'm two years into a 30-year fixed-rate mortgage.
So, do you think it is a good way of paying off my credit cards
and improving my credit, or should I gradually pay off my cards
starting with the high interest rate ones and pay off at least 50
percent within the next six months? Please advise.
-- Thanks,
John Joust
 Dear
John,
I'd much rather see you keep that 6 percent mortgage. If closing
costs on the refinancing are $3,000, you've just spent 15 percent
of your outstanding credit card debt just for the privilege of making
it secured mortgage debt that you can repay over the next 15 to
30 years.
With close to $200,000 equity in your home, a home equity loan
or a home equity line of credit (HELOC) is a much smarter way to
restructure your credit card debt. The closing costs will be much
lower than the costs associated with refinancing the first mortgage
and you will be paying the higher interest rate on just the home
equity debt. There are pros and cons to both types of home equity
debt. I'd lean toward the HELOC, even though it is variable rate
debt, if you don't have much of a cash reserve for emergencies,
and toward the home equity loan if you're fairly comfortable with
your cash reserves.
Key in all this is to not use the sudden influx of credit as an
excuse to run up your credit card balances all over again. View
the home equity line/loan as a restructuring of your credit card
debt, not a license to spend more. If you take this approach, you'll
have changed your unsecured credit to secured credit, backed by
the equity in your home. You still need to get spending under control
and work on paying off the equity line as quickly as is practical.
You don't want to finance this year's holiday spending over the
next 20 years.
Credit card companies use risk-based modeling to determine what
interest rate you pay on your credit card. You didn't get a 30 percent
rate on your credit card by paying your bills on time. Paying down
these card balances will do a lot toward improving your credit.
As you move toward accomplishing this goal, talk to the card providers
about lowering the interest rate on your credit cards. It'll be
a good barometer for whether or not you want to stay with these
firms when your credit does improve.
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