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Don’t Refinance Home To Repay Debt

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You have a car loan that currently sits at 7% interest, you have credit card debt that currently sits at 14.99%, and you have the option of rolling both of those loans into a new loan after you refinance your home… should you do it? Probably not and there are two good reasons and one pretty good reason why.

Good Reason #1: You Pay More Interest

Usually car loans are for five years so when you’re paying 7% interest each year, you’re really only paying it for five years so the total interest cost is relatively low. When you refinance a loan, say to a 30 year fixed or some sort of low rate ARM, you’re now paying for the lower rate, 6% or whatever, for thirty years. Five years at 7% on $10,000 means you’ll pay $1,880.60 in interest. Thirty years at 6% on $10,000 means you’ll pay $11,585.60 (you may be able to deduct it from your taxes so the interest really is three-fourths of that, or $8688.75).

Good Reason #2: If You Miss Payments, You Lose Your House

One of the many fallout stories with the mortgage industry is that of folks who refinanced in order to pay down their debt, in this case it was car and medical bills (so I can understand, there isn’t a choice at least with medical bills), and then found themselves unable to keep up with the payments. If you have a car loan and you can’t make payments, they take the car and you ride the bus. If it’s a credit card debt, it just goes into collections and you won’t get another card. If you have a mortgage payment and you can’t make payments, they foreclose on you and you have to find someplace else to live!

Pretty Good Reason #3: The Pressure To Pay Is Good For You

This isn’t a financial reason, it’s a psychological reason and so that’s why I say it’s only a “pretty good” reason. With a higher interest rate, you feel the pressure of paying it off and so you’re more likely to pay it off. If you roll it into a large mortgage payment, well you no longer feel the pressure and you’re likely to keep charging (if it’s a credit card).

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7 Responses to “Don’t Refinance Home To Repay Debt”

  1. MoneyNing says:

    Good Comments #1: But I wonder what the math would work out to if we were able to invest the extra money we don’t have to pay per month since we pay less each month for a 30 year fixed mortgage than a 5 year car loan for the same amount.

    Good Comments #2: Do we know how much power credit card and car loan companies have if we don’t pay our debts? Couldn’t they eventually tap into our homeownership?

    Pretty Good Comments #3: I really hope mortgage payments aren’t that much of a pressure since I’m contemplating about buying a house but I’m scared of the mortgage payments!!!

  2. pcooper says:

    Nothing stops you from financing the car loan into your mortgage, and then paying down that portion of the debt on a 5-year schedule anyway. The 30 years forms the minimum amount that the bank requires of you, but you can pay it down (or part of it down) quicker if you want.

  3. Chris says:

    Unfortunately most people, I think, refinance with their homes in order to reduce the monthly payments that they can’t afford. They probably won’t be paying extra into the mortgage to cover the car loan rolled into it. They’ll just pay the new mortgage and forget about it.

  4. Tanelia says:

    You forgot the fact that once they’ve refinanced, and the cards are paid, some people think it’s alright to go ahead and charge the CC all over again, which only results in more debt.

  5. Projoe says:

    I’m one of those sub primers you hear about on the news. My wife and I bought a house in Feb. 2006 on a 2 year ARM. Knowing what I know now I shouldn’t have gone that route, but it was the only way we could have gotten a house back then. Now though, we both think we should have waited a year or so to get a house just so that our finances were in a better state, but even still we’ve never missed a payment. Anyways, We pay a penalty if we refinance any earlier than 2 years, so I have to wait until then to do so, but I plan on refinancing as soon as possible. At that time if the option to throw my car loan is available I plan on doing so to free up that money so I can spend it on other debts we have. I figure the quicker I can pay off the credit cards I have and the student loans my wife have the quicker we’ll be able to doubling up on payments to the house or investing in retirement.

  6. Chris says:

    Well, you’re not really paying them off, you’re just moving them around. If you have a $300 car payment and roll the principle into your mortgage, you still have a $300 car payment. It’s just wrapped up in the mortgage, they stretch it out, and now you’re paying maybe $50/mo for 30 years. If you pay $300 extra into the mortgage you’re not even touching your mortgage principle, you’re just paying your car payment to a different bank.

    I think as pcooper said, you would really have to track the numbers to make sure you are coming out ahead. If you have really high interest credit cards, is a personal loan from a bank or credit union not possible? One of those with a 5 year term would be better than putting it into a mortgage. The student loans should be getting a better rate than the mortgage, so why roll that one in too?

    If you put your car loan into the mortgage, and then use that payment to pay off other debts instead, you are going to end up paying more for the car in the end. I just think home equity loans and rollovers like this are a complete ripoff for most people. It shouldn’t be used as an easy way out of debt, IMO.

  7. Scott says:

    Here’s a story from a former colleague of mine. If remember the timeframe correctly, he pulled off this feat sometime around the first of this year.

    Borrowed $10,000 from his parents and wife’s parents (really bad idea #1)
    Used the $10,000 to fix up his house (not so bad) so that it would appraise at a higher value (uh oh…)
    Took out a home equity loan of around $40,000 (really bad idea #2)
    Used the $40,000 to pay off as much of his credit card debt, car loan, student loans, and other loans as possible… and to pay back his parents and her parents
    And then his wife (who doesn’t work) promptly got pregnant again (really bad idea #3)
    And I’m pretty sure the credit card bills started stacking up again…

    To even have the need to pull this off, this guy is living FAR beyond his means and IMO needs to (1) stop having kids, (2) tell his wife to get a job or stop spending money, and most importantly (3) stop borrowing money. The “American Dream” or whatever you want to call it has never been free despite some people’s perception that it should be. Most of our parents had to bust their butts to get where they are – our generation should expect the same but sadly many feel that false sense of “entitlement”.


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