Don’t use plastic to pay down mortgage

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Dear Debt Adviser,
I have a mortgage of $213,000 on a home valued at $276,000. My credit score is 713. I’m wondering if I would be better off to max out all my credit cards — the combined limit total is approximately $70,000 — and pay down my mortgage? Can you advise?
— Joyce

Dear Joyce,
This is a really bad idea from almost every perspective. Let me explain why.

From your letter, I am going to make a couple of assumptions. First, you believe you can get a better interest rate using your credit cards than what you are currently paying on your mortgage loan.

Second, you believe that lowering the amount you owe on your mortgage will benefit you.

Based on those assumptions, here is my advice.

Although you might pay less in interest charges on the approximately $70,000 you would charge on your cards, you would have to come up with a monthly payment of around $700 per month to pay off the cards. This would be in addition to your current mortgage payment, which would stay the same.

If you can afford an additional $700 per month, I suggest you consider other uses for the money. One would be to put it toward principal payments on your existing mortgage loan.

Many people forget that credit card issuers have the right to change the terms of your card agreement for many reasons. If you should end up with a default interest rate for any reason — including a reduced credit score or increased ratio between “credit available” and “credit used” under a universal default clause — you could see your interest rate go to a nosebleed 30 percent.

Universal default is incurred when your credit card lender looks at your overall financial picture and concludes that you are now a greater risk than it thought you once were.

As a result, the lender may raise your interest rate to compensate itself for the additional risk. Some say lenders do this just because they can. But either way, this can be a self-fulfilling prophesy, as the huge interest rate can drive you into a financial calamity.

The tipping point for adding a negative to your credit history is usually when your card debt ratio is 50 percent or more of your credit limit used.

In addition, this new credit card debt might damage your credit score, making it more difficult for you to refinance your mortgage should rates drop in the future.

Moreover, you already have more than 20 percent equity in your home without paying down the mortgage any further. This is a significant milestone, as lenders historically have been willing to finance 80 percent of a home’s value in a conventional mortgage.

Use the Bankrate mortgage calculator to do the math on how paying an additional $700 per month to the principal of your mortgage would affect your total amount owed. For a 30-year fixed rate mortgage of $213,000 with a rate of 7 percent interest, your monthly payment would be $1,417.09 and you would pay $1,986 toward your principal for the first year of the loan.

If you added an additional $700 principal payment each month, you would increase the total amount paid in one year toward the principal amount of the loan to $10,838.

So, over the next seven years, you will be decreasing your principal by about $70,000, but you have far less risk to your credit and your financial stability.

Be sure to check the terms of your mortgage loan to assure you can make principal payments without penalty.

Finally, if I had an extra $700 in unallocated cash flow each month, I’d be adding to my emergency fund to get it to the full six months of expenses that I recommend for unexpected bumps in the road.

The road is already bumpy and no one knows what new excitement lies around the next corner. Save, save and then save some more!