Should you roll debt into your mortgage?

How a cash-out refinance pays off other debts

A cash-out refinance replaces your current mortgage with a bigger loan. The lender pays off your old mortgage. The extra money pays your other debts at closing. After that, the debts it pays off become part of one loan, and your house secures that loan.

This can make your bills easier to manage. You make one payment instead of several. But the total cost depends on three things: the size of the new loan, its rate, and its term. Look at all three before you decide.

Ask how each old debt will be paid at closing. Confirm that each balance is paid in full. A debt that is not paid in full can stay open, and you still owe it.

A lower rate over a longer time

Consider a $25,000 car loan at 7% for 5 years. The monthly payment is $495. The total interest is $4,702.

Now consider the same $25,000 at 6.5% over 30 years. The monthly payment is $158. The total interest is $31,884.

The second loan has a lower rate. Its payment is lower too. But it costs $27,182 more in interest. The longer term is the reason. You pay interest for 30 years instead of 5, and each year adds interest, even at a lower rate. A lower rate does not always mean a lower cost.

When consolidation can make sense

Consolidation can help in some cases. The first case is debt at a much higher rate. Credit card debt often carries a high rate. Moving that balance to a lower rate can reduce the interest you pay.

The second case is a firm plan to repay the new balance quickly. A 30-year term is slow. If you keep the 30-year term and pay only the minimum, the interest adds up. If you pay the balance off in a few years, the result can look very different.

Ask yourself these questions before you decide:

What rate does each of my debts carry now?
How many years will it take me to repay the new balance?
Will I run up the cards again after closing?

The last question matters. If you run up the cards again, you will owe the larger mortgage and new card debt.

The risk

Credit card debt and many personal loans are unsecured. No asset backs them, so the lender has no claim on your house for that debt. A car loan is different: the car secures it. After the refinance, your house secures that debt instead.

After a cash-out refinance, that debt becomes part of your mortgage. Your house now secures it. If you cannot make the mortgage payments, you can lose your home. This is the main risk of consolidation.

Think about it before you start. Consider your income, your job, and your savings. Plan for a bad month too. Ask what happens to your budget if a payment is late.

After closing, the card balances are gone, and the monthly bills look smaller. That can hide the new risk. Your house now stands behind the debt, so a missed mortgage payment has bigger effects than a missed card payment.

Before you decide

Gather your numbers first. List each debt, its balance, and its rate. Ask for a written estimate of the closing costs. Closing costs add to the cost of the new loan, so include them in your comparison.

Then compare the total cost of the new loan with the total cost of your current plan. Do not compare only the monthly payment. A smaller payment can hide a larger total.

Talk with a housing counselor or a financial adviser you trust before you sign. They can review your full situation. They can also point out costs that are easy to miss.

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