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02-02-2009, 04:41 PM #1
- Join Date
- Jan 2007
- Newberry, SC
- Blog Entries
Don't Mortgage Your Future to Pay Credit Cards
By Suze Orman
Don’t Mortgage Future to Pay off Cards
I am seeing a lot of households play the dangerous and costly game of rolling their credit card debt into mortgage debt, and that has me very concerned.
What’s happening is that just as credit card interest rates are shooting up to 30% or higher, mortgage rates are falling to historic lows. The 30-year fixed rate touched down at 5% this past week. That has a lot of you thinking it’s a great move to get rid of your super-expensive credit card balance by refinancing your mortgage, taking out some equity in your home, and using the payout to pay off your credit card debt. Sure that reduces the interest rate you must pay, but you are still stuck with the debt, and if you’re not careful you’ve put your family at additional financial risk if you increase your mortgage amount in the process of consolidating your credit card debt. And what really has me concerned is that when people can “easily” wipe out credit card debt they don’t learn anything, and so six months later they have run up their card balances yet again.
Hey I realize it doesn’t help that the Federal Reserve is practically goading you into swapping credit card debt for mortgage debt. Last month the Federal Reserve announced pro-consumer changes to the regulations governing credit cards. Among the changes is that card companies will no longer be able to impose higher interest rates on an existing balance as long as you continue to make timely payments. Card companies will also no longer be able to automatically target your payments to cover balances charging the lowest interest rate. That’s all great news, but the new regulations don’t go into effect until July 2010. Why so long? Well, the banks would tell you they need time to change their technology to deal with the new rules. But I think perhaps the Fed is concerned that the already stressed out banks that are big in the credit card industry couldn’t handle the change to their bottom line if the rules hit right now while banks are struggling to survive. So in the meantime, credit card companies (which are the very banks that have been decimated in the financial credit crisis) are still free to ratchet up rates on even their “good” customers.
In the past you could maintain a reasonable interest rate on your card as long as you paid at least the minimum balance due each month. But now paying just the minimum due is a red flag to credit card companies and a reason to raise your rate. Some people who have done nothing “wrong” have seen their rates skyrocket from 10% or so up to 30%. That’s insane.
At the same time, the Fed is doing everything in its power to push lending rates down. While the Fed funds rate doesn’t directly cause changes to the 30-year fixed rate mortgage, the impact of the Fed’s recent decision to lower its Federal Funds rate to near zero has indeed play a large role in pushing rates down across the board. The 5% interest rate you can get on a 30-year fixed rate mortgage is the lowest in more than 35 years.
I want to make sure that anyone considering a mortgage refinance to deal with credit card debt proceeds with caution.
Don’t Rush to Tap Equity to Pay off Credit Cards. For those of you lucky enough to still have a lot of home equity, please think hard before using it up to pay off credit card debt. It’s one thing to tap a small amount, but if you in fact are increasing your mortgage amount through a refinancing, or you are able to tap a HELOC, you are potentially creating a huge new risk for your family. Sure the credit card debt is expensive, but it is unsecured. When you consolidate the credit card debt into a mortgage or take out a HELOC to pay off the credit card debt, you have shifted that unsecured debt into secured debt: your home is the collateral. If something happens, such as losing your job or having a serious illness that prevents you from working and you can’t keep up with the mortgage and/or HELOC payments you run the risk of losing your house.
Be Refi Smart: I do think there are some smart ways to refinance. I obviously don’t want you increasing your mortgage amount. I also want you to refinance into a loan that does not extend your total mortgage term past the original 30 years. So for example, if you have paid off five years on your current mortgage, you are to refinance into a new 25 year loan. Please don’t make the mistake of refinancing into a new 30 year loan, for that extends your total mortgage term to 35 years. Odds are that will result in higher total interest payments over the life of the loan.
The goal is to simply convert the existing mortgage amount to a lower interest rate; then use the money you will save each month to pay off your credit card debt.
Pay Attention to the Fine Print: While mortgage rates are near historic lows, you need to understand that a 5% rate is only going to be offered to customers with pristine credit records. That means a FICO credit score of at least 720. Chances are if you have a big credit card balance your FICO score isn’t going to be that strong right now. That doesn’t mean you won’t be able to refinance, it just means you might be offered a higher interest rate or be stuck paying more fees to refinance. Before you rush to refinance read the documentation carefully to make sure you understand all the costs. Only then can you know for sure that refinancing is a smart move.
Cut your Spending: Borrowing more on your house to pay off credit card debt doesn’t solve anything. You haven’t gotten ahead, you have just shifted your debt around, albeit to a lower interest rate. As I explain in my 2009 Action Plan, the only way to start laying a foundation for long-term financial security is to get out of debt, not shift it around. While lowering your mortgage payments is indeed a good way to free up more money for paying off other debts, I don’t want you to stop there. You also should get serious about scaling back your spending. I challenge you to find $100 or more a month you can cut from your current monthly expenses. Pull out your bank statements and credit cards. Circle every expense that is a “want” rather than a need. I think every “want” should be put on the chopping block this year; either eliminate it completely or find a way to reduce the cost; scaling back the platinum cable package to basic is one example. If you want use the expense sheet that we have created for you under action updates and it will help show you the way.
Don’t Run up New Balances: The absolute worst move you can make is to get rid of your credit card debt via a mortgage refinance, and then turnaround and run up new credit card bills. That is always stupid in my book, but in 2009 it is just beyond insane. The goal is to reduce your debt FOREVER. Not to play some sort of crazy game where you wipe it out so you can just run yourself right back into 30% interest rate charges. Don’t do it!
Last edited by d_awalker; 02-02-2009 at 11:37 PM.