Dear Dr. Don,
I have an existing mortgage with Bank of America on which I still owe $86,000; the interest rate is 6.125 percent and the monthly payment is $607. I still have 25 years and eight months left on this loan. I also have $30,000 of combined credit card debt. According to Zillow.com, my home is worth about $135,000.

I want to refinance my mortgage (plus my credit card debt) for sure, but am confused as to whether I should go for cash-out refinance or traditional refinance on the first mortgage, and home equity on my credit card debt. Please advise on the best course of action.
— Jasveen Jericho

Dear Jasveen,
You need to reflect on how you got to the point of having $30,000 in credit card debt in the first place. If you’re spending more than you make, consolidating credit card debt into a mortgage just postpones the day when you have to get spending under control.

Your credit card debt is an unsecured loan. If you use a mortgage debt to pay off your credit cards, you’ve securitized that debt. The credit card companies get their money, but you’ve just bet the house on managing your finances better in the future than you’re doing today.

Consolidating the debt does allow you to reduce the interest rate on your credit card debt, and the interest expense may generate a tax deduction on your income taxes. However, you could wind up taking 30 years to pay off the credit cards, resulting in higher total interest expense. Also, will you have the financial discipline to not run up credit card balances now that you have those balances paid off?

Using a cash-out first mortgage for debt consolidation is problematic because you don’t have enough equity in your home to be able to avoid the lender requiring private mortgage insurance. That raises the cost.

Lenders are also becoming more conservative in how much money they will allow a homeowner to receive in a cash-out refinancing. That (along with paying several thousand dollars more in closing costs on a first mortgage versus a second mortgage) means you should at least consider using a second mortgage instead of a cash-out refinancing of your first mortgage.

As I write this reply, Bankrate’s national averages for home equity loans are 5.7 percent for a home equity line of credit and 7.6 percent for a home equity loan. The HELOC is an adjustable-rate loan, while the home equity loan is a fixed-rate loan.

If you plan on aggressively paying down the loan over the next two to three years, the interest rate risk in the HELOC is manageable. Otherwise, the fixed rate of the home equity loan makes sense.

Alternately, you could do a cash-out refinancing up to the point where you have 80 percent loan-to-value, thus avoiding PMI. That would pay off about $22,000 of the credit card debt. If you have a good credit history, you may be able to justify refinancing the first mortgage.

(As I write this, mortgage rates today (according to Bankrate’s national average) for a 30-year fixed-rate loan are 5.22 percent, almost a full percentage point below the current rate on your existing mortgage.)

Then, work on paying off the remaining credit card debt. This presumes that you plan on being in the house long enough to justify refinancing the first mortgage.

Bankrate’s mortgage debt consolidation calculator and its refinance interest savings calculator can help you decide which approach is best for you.

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