Dear Dr. Don,

We have eight years and $74,000 left to pay on a 15-year home mortgage with a 5.25 percent mortgage rate.

There’s also a home equity loan at 6.5 percent with a $22,000 balance and a balloon payment due in 2013. We used the home equity loan to build a garage. Our credit union lender says there won’t be a problem in refinancing the home equity loan when the balloon payment comes due.

The approximate market value of the house is about $155,000. What’s our problem? Over time, we have accumulated about $20,000 in credit card debt.

We cannot currently afford to pay extra on the debt each month because our monthly income is just meeting our obligations. We have no extra money at the end of the month for emergencies, etc. Our household annual income is close to $80,000.

I called our lender and refinancing our balance over 20 years will only lower our payment about $400, and the rate will be slightly higher.

So, should we look at refinancing our home (principal only) to lower our housing costs so we can have the flexibility to pay off the credit card debt? Or should we look into credit counseling?

— Troubled Tracy

Dear Tracy,

Being more than halfway through a 15-year mortgage is great, but that financial move appears to have been too aggressive. You’re not able to live within your means and as a result, you’re using credit cards to pay for current consumption.

Credit counseling isn’t likely to be an answer because you’re not behind on the bills. Rather, you’re just not able to get ahead by paying down those bills. Bankrate’s “10 questions to ask a credit counselor” and the FTC Facts for Consumers publication “Fiscal Fitness: Choosing a Credit Counselor” provide a nice overview of what credit counseling can do for you.

You need to free up some money each month so you can pay down the credit card debt. Extending the term on your home mortgage would accomplish that goal, as would consolidating your credit card debt into a mortgage by doing a cash-out mortgage refinance.

Extending the mortgage to 20 years frees up $400 per month, or $4,800 per year. You can even combine the two tactics to free up enough monthly funds to allow you to live within your means.

You seem reluctant to consolidate the debt. That’s OK. Securitizing credit card debt by folding it into a mortgage isn’t always the right answer for homeowners. If you don’t make a credit card payment, it hurts your credit score. But fail to make mortgage payments and you can lose your home.

Personally, I’d consolidate the credit card debt with the two mortgages, provided there’s not a big prepayment penalty on the home equity loan. To take that approach, you have to be disciplined enough not to run up your credit card balances again.

If you don’t think you have that discipline, just consolidate the first mortgage and the home equity mortgage into a new 15-year fixed-rate mortgage. I’ve run the numbers below. They’re estimates based on what you’ve told me, but run your own numbers by using Bankrate’s mortgage calculator.

Debt consolidation comparisons
Existing 1st mortgage Existing 2nd mortgage Totals
Initial loan: $76,000 $22,000
Interest rate: 5.25 percent 6.5 percent
Loan term (months): 78 144
Monthly payment: $1,152.16 $220.42 $1,372.58
Total interest: $13,868 $9,741 $23,609
New 15-year with debt consolidation New 20-year with debt consolidation New 30-year with debt consolidation
Initial loan: $118,000 $118,000 $118,000
Interest rate: 4.88 percent 5.13 percent 5.38 percent
Loan term (months): 180 240 360
Monthly payment: $925.78 $787.25 $661.13
Total interest: $48,640 $70,939 $120,008
New 15-year mortgage refinancing New 20-year mortgage refinancing New 30-year mortgage refinancing
Initial loan: $98,000 $98,000 $98,000
Interest rate: 4.88 percent 5.13 percent 5.38 percent
Loan term (months): 180 240 360
Monthly payment: $768.87 $653.82 $549.08
Total interest: $40,396 $58,916 $99,668

I like the 15-year with debt consolidation because you’ve reduced the monthly mortgage payment from $1,373 to $926 and the home mortgage includes the credit card debt. Between the $450 per month reduction in mortgage payments and having no credit card payments due, you should be able to make additional principal payments on the mortgage. This will reduce the loan term and the interest paid.

Another goal should be building an emergency fund with some of the money freed up in your monthly spending plan. Also, do not run up any credit card balances. You can make this work.

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