$1 Trillion in Credit Card Debt is Crushing Americans. Time to Consolidate Using Home Equity?

With credit card rates for many consumers running between 25% and 30%, getting ahead of the compounding interest can be challenging. For homeowners with equity in their property, a cash-out refinance may reduce monthly payments.

But is consolidating credit card debt with a cash-out refinance a good idea? Let’s see how debt consolidation refinance work out in a couple of different scenarios.

Using a Cash-Out Refinance to Consolidate Your Credit Card Debt

Why would someone use a cash-out refinance to consolidate credit card debt? Most often, it's to reduce colossal interest rates (and monthly payments) and to get growing or tough-to-tackle balances under control.

Credit Card Interest Rates

The Federal Reserve’s most recent data, covering August 2023, shows the average credit card interest rate at 21.19% - the highest since the Fed began tracking in 1994.

For many borrowers, it’s not uncommon for rates to run 25% or higher. Someone who has missed payments or had other recent credit issues may even be paying more than 30%.

Refinancing the debt to your mortgage will often trim your monthly obligations. It may even reduce your total interest in some situations.

Credit Card Debt

Interest rates aren't the only thing at an all-time high; so is overall credit card debt. According to the New York Fed, nationwide credit card balances reached $1.08 trillion in the third quarter of 2023.

With both credit card debt and interest rates at unprecedented highs, it's easy to understand why homeowners – especially those who have seen their properties rapidly appreciate – may want to cash in some equity and consolidate their payments.

How Much Does High-Interest Credit Card Debt Cost?

Credit cards are a type of unsecured debt and have some of the highest interest rates. Paying the minimum amount required could mean costly interest charges over an extended period.

For Example: If you maintain $30,000 of credit card debt that has an average interest rate of 25%, you are paying around $7,500 a year just in interest payments. That’s $625 per month.

Unlike loans with a fixed term, it can be challenging to calculate the lifetime interest costs of credit card debt. A few reasons why include:

1. Banks have different minimum payment requirements

2. Repayment goals vary from person to person

3. Some borrowers add to their balance as soon as they pay a portion down

What Is a Good Repayment Plan for Credit Card Debt?

Many experts recommend a repayment plan eliminating your outstanding debt in 36 months. For the example above of $30,000 of debt at 25% interest, that would require a monthly payment of nearly $1,200.

Over this three-year repayment period, you would pay around $12,950 in interest.

Longer Repayment Periods

But what if that $1,200 monthly payment wasn’t feasible? What if you can only budget for the current 3% minimum monthly payment of $900 but could continue paying that amount as your balance declines?

In this scenario, it would take you 58 months to pay off your credit cards – about five years. The total amount of interest would be $21,750.

Now, imagine if you continued to make the minimum payment each month. Your credit card debt could stretch for years, compounding at every step of the way.

Reducing Interest Rates With a Cash-Out Refinance

Mortgages have also increased in recent years but are far from what you'll see with an unsecured credit card. Plus, lender rates have been dropping over the past few months.

It’s possible for qualified borrowers to get a cash-out refinance for between 6% and 7%, with the opportunity expanding if rates continue to fall in 2024.

So, how much could you save by paying off your credit cards with a cash-out refinance?

For Example: If you have $30,000 in credit card debt and are making a 3% monthly payment, that's $900. Refinanced with a 30-year mortgage at 6%, that debt payment shrinks to just $180. Even on a 15-year cash-out refinance at 6%, you’re only paying around $250 monthly for the added balance.

But what about the total interest paid? Over a 15-year mortgage at 6%, you'd only pay $15,570 in interest – substantially less than in the previous example ($21,750 in interest) paying off your credit cards in around five years.

With a 30-year mortgage at 6%, you’d pay $34,750 in interest over the life of the loan. But this may still be cheaper than paying down credit cards over many years. It may also be better for homeowners with newer 30-year mortgages who may not be able to afford the payments of a shorter-term loan.

Borrowers Refinancing From a Higher-Rate Mortgage

If you purchased or refinanced your home in the past couple of years, you may be able to refinance at a lower rate. Combined with your high-interest credit card debt, this could result in considerable monthly savings.

For Example: You currently have a 30-year mortgage for $160,000 at 7.5% interest. The remaining balance is $150,000. You also have $30,000 of credit card debt with an average rate of 25%. You're pre-qualified to refinance for $180,000 at 6% interest.*

With the current arrangement, you'd pay more than $2,000 a month between your mortgage and credit card minimums. But what about if you refinanced both debts together?

In this scenario, refinancing your home loan to pay off your credit cards would cut your payments almost in half. In fact, wrapping your credit card debt into your home loan would cost less monthly than your existing mortgage.

Borrowers Refinancing From a Lower-Rate Mortgage

If you have owned your home a little longer, you might be locked into a lower mortgage rate than lenders currently offer. However, a cash-out refinance could still be a practical option for some consumers facing high-interest credit card bills.

For Example: You currently have a 30-year mortgage for $175,000 at 3.5% interest. The remaining balance is $150,000. You also have $30,000 in credit card debt with an average rate of 25%. You're pre-qualified to refinance for $180,000 at 6% interest.

Your current mortgage and credit card minimums have you paying $1,690 per month. But what about combined through a cash-out refinance?

Even though you’re increasing the interest rate on your mortgage, you’re still saving more than $600 per month thanks to reducing interest on the credit card portion of your debt and amortizing it over an extended period.

It’s also interesting that you’ll pay a lower blended rate by combining your mortgage and credit card debt. You’ll drop from a blended rate of 7.08% on combined debt down to 6%.

This is an opportunity for borrowers who need to reduce their monthly payments and prefer to do so with a single loan. But if you currently have a low interest rate, you may want to think about second mortgage options. We'll touch on that option toward the end of this article.

Be Sure to Consider Closing Costs

Deciding whether a cash-out refinance is the best way to pay off your credit card debt isn't just about interest rates. When you refinance a mortgage, you pay closing costs, often 2% to 4% of the total loan amount.

In some situations, these costs may impact your decision to refinance.

For Example: If you have an existing loan of $100,000 and want to borrow $30,000 to pay off your credit card debt, you’ll pay closing costs on the new $130,000 mortgage. At 3%, this would be $3,900.

But what if your current mortgage was larger?

For Example: If you have an existing loan of $250,000 and want to borrow $30,000 to pay off your credit card debt, you’ll pay closing costs on the new $280,000 mortgage. At 3%, this would be $8,400.

In this scenario, it might not make sense to pay closing costs equal to more than 25% of the borrowed amount.

Risks of Paying Credit Card Debt with a Cash-Out Refinance

Even if it sounds like a cash-out refinance may be a good solution for paying off your credit card debt, there are a couple of risks you should consider:

Credit Card Debt Is Unsecured

Most consumers who can’t make their credit card payments eventually have the debt written off. There are generally few severe repercussions besides the damage to their credit report and neverending calls from bill collectors.

On the other hand, refinancing your credit card debt into your home loan is securing it with your property. If one day you aren't able to make your combined mortgage payment, your lender could legally come after your house.

Spending Habits Are Hard to Change

If your credit card debt is the result of unsustainable spending habits, consolidating with a cash-out refinance isn’t likely to solve your problems. It’s easy to run up your accounts again.

In this situation, you'd wind up in the same position as before but without the equity in your home to fall back on.

Refinance to Pay Off - Not Close - Your Credit Cards

If you're using your home's equity to pay off your credit cards, try not to close the accounts. While it may seem counterintuitive, closing your paid-off accounts can hurt your credit score.

That’s because open credit accounts impact two main score factors: age of credit history and credit utilization ratio.

Closing a card reduces the total amount of credit that's available to you, increasing your credit utilization ratio (a bad thing). Closing a seasoned account is also likely to reduce the average age of your credit accounts. The older your credit history, the better.

Qualifying for a Cash-Out Refinance With Credit Card Debt

First, you must have enough equity to qualify for a cash-out refinance. Conventional lenders will refinance up to 80% of your home's value, including the amount of equity you want to withdraw.

For Example: If your home is worth $300,000, lenders would generally be willing to loan up to $240,000. If you owe $200,000 on your current mortgage, you could withdraw up to $40,000 in equity minus closing costs and fees.

Apart from equity requirements, refinancing your mortgage is similar to taking out a regular home loan. You'll still need to meet lending guidelines regarding your credit. For a conventional cash-out refinance, this means a minimum credit score of 620.

Debt-to-Income Requirements

If you're applying for a conventional refinance, you'll also need a debt-to-income (DTI) ratio of 45% or below. That means your monthly debt obligations, including your mortgage and minimum credit card payments, can't total more than 45% of your income.

This requirement could pose an issue for many borrowers trying to refinance away from crippling credit card interest payments.

Thankfully, Fannie Mae guidelines allow lenders to ignore revolving accounts (like credit cards) which will be paid in full with the refinance. If you’re planning to consolidate credit card debt with home equity, your lender may be able to qualify you based on your anticipated DTI post-refinance.

Note: Some lenders may be able to approve you with a DTI as high as 50% if you provide proof of having six months of mortgage payments (PITIA) held in reserve.

Alternative Strategies for Consolidating Credit Card Debt

If you’re not sure that a cash-out refinance is the best solution for paying off your credit card debt, don’t worry. You still have other options, including alternatives for tapping into your home’s equity.

Home Equity Loan or Line of Credit

With a home equity loan or line of credit, you can access your equity without refinancing your current mortgage. Plus, home equity lines come with low or no closing costs. A home equity line of credit even allows you to make multiple cash withdrawals over a period of time.

But while these second mortgage options have lower rates than unsecured credit cards, expect to pay a much higher percentage than you would with a conventional cash-out refinance.

Personal Loan

Like credit cards, a personal loan is an unsecured debt based primarily on your credit and financial profile. Interest rates for personal loans are lower than on credit cards but higher than on loans secured by your property.

For those who qualify, personal loans are a simple consolidation option that can be funded much faster than your typical refinance. In many cases, personal loans can be made within a week.

0% or Low-APR Balance Transfer

One of the easiest and cheapest ways to get a grip on credit card debt is through a 0% or low-APR balance transfer. It’s not uncommon for banks to offer promotional transfer rates to entice new credit accounts.

Just note when the promotional period ends and plan to pay off – or re-transfer – your debt before interest rates skyrocket.

Is a Cash-Out Refinance the Best Option for Credit Card Debt?

Not everyone with credit card debt should pay it off with their home’s equity. But for some homeowners, especially those with high-interest credit cards, a cash-out refinance may be the most practical choice.

Get in touch with an experienced mortgage broker for a comprehensive idea of how paying off your credit cards with a cash-out refinance could impact your interest rates and payments.

*Note: These are basic estimates based on example rates and don't include variable factors like taxes, insurance, and closing costs. Talk with a lending professional for a more comprehensive idea of how a cash-out refinance may affect your payments.