Don't Refinance More Than You Can Handle

By Benny L. Kass
Saturday, May 16, 2009

Q: With mortgage rates at record lows, I'm thinking of refinancing my 30-year, fixed-rate loan. The lender is recommending that I roll into the refi amount the balances I owe on my car and two credit cards. The advantages would be that they would be paid off, the interest rate would be lower than I'm paying on them and the interest would be tax-deductible.

But I think I'm seeing a big disadvantage. The total of the amounts on my five-year car loan (on which I still have three years to pay) and the revolving loans would be amortized over 30 years. Does it make sense to do that? How can I figure out whether it's a smart move?

A: You have to review a number of factors before you can make up your mind. Here are some of the pros and cons:

-- Pros: As you suggested, the rate on your new mortgage would be lower than what you have now. Furthermore, the mortgage interest is probably deductible, unlike the interest on your car loan and your credit card.

You should talk with your tax adviser to determine how much of the new interest you would be able to deduct. There's a limit -- you can deduct interest only on the amount of the old loan at the time of the refinance (called "acquisition indebtedness") plus $100,000. While I doubt that the combined debts you are considering rolling into the new loan will be more than $100,000, it is important to know the facts.

-- Cons: You could pay off your car loan in three years, but if you put that debt into your mortgage, you will be obligated to make monthly payments for 30 years. You can, of course, shorten the term by making additional payments.

Another possible negative is that by increasing your loan, you will have less equity in your home. This might affect the cost of your mortgage. For example, if your house is appraised at $400,000, you get a better interest rate if you have at least 20 percent equity -- that is, if you borrow no more than $320,000. You also want to make sure that adding the extra debt doesn't jack your loan up into the "jumbo" category, which also costs more. Either situation could increase your monthly payments enough to offset any gains from the consolidation.

I ran your question by Jack Guttentag, who writes the Mortgage Professor column, which sometimes appears in this section. He pointed out another negative. "If the borrower encounters stormy financial weather ahead, he or she has converted unsecured debt into secured debt, which will increase the likelihood that the borrower will lose the house," he said.

Is your job secure? Do you have sufficient savings to cover the mortgage should you fall on hard times? How long do you plan to keep the house?

I'm not flat-out opposed to consolidating debt in a new mortgage. However, a better option might be to refinance your home loan and use the savings to pay off or pay down your car loan and credit card debt.

That way, you won't increase your loan amount, but you'll be able to reduce those unsecured debts.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.


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