* Should I refinance my home equity loan to consolidate my credit card debt?
My first mortgage balance is $190k at 4%pa. I have a home equity line of $170k that I have fully utilized. I am also a $30k credit card debt.
Should I refinance my home equity loan to consolidate my credit card debt?
Obviously it is advantageous for you to consolidate your credit card debt because:
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(a) you will save interest because you will be using the cheaper home equity loan to replace your more expensive credit card loan, and
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(b) having your credit card debt paid off will result in a lower credit card utilization rate which in turn will improve your credit score.
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Financing option
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How are you going to raise the $30k to clear your credit card debt?
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(1) One option is to increase your home equity line by $30k, assuming that you still have available home equity to do so. This will bring your total home equity debt up to $200k.
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(2) The other option is to ask your first mortgage lender to lend you another $200k that you will then use to pay off both your home equity loan and credit card debt. This is advantageous because first mortgage is usually cheaper than second home loan such as your home equity loan.
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Points to note
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(A) Your current situation has a tax disadvantage here. While you can deduct your home equity loan interest for tax purposes, your eligible home equity loan is limited to a maximum of $100k only. The interest you pay on the remaining $70k of your home equity loan is not eligible for tax deduction. Financing option (1) stated above will not increase your tax deduction for the loan interest.
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If you choose financing option (2) to borrow the $200k (ie $170k + $30k) from your first mortgage lender, you will increase your interest savings as mortgage interest rates are lower than home equity loan rates. Of this $200k new first mortgage, interest on $100k is still eligible for tax deduction.
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It does not matter what the loan is called, either first mortgage or home equity loan. For the purposes of tax deduction for mortgage interest, as long as the loan secured on your home is not used for buying or improving your home, the loan amount — whose interest is eligible for tax deduction — is limited to a maximum of $100k only.
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(B) You should ascertain the appraised value of your home. If your total borrowings exceed 80% of your home’s appraised value, you will have to buy private mortgage insurance (PMI) to protect your lender against your default. PMI will increase your loan costs. Your total borrowings will be $390k (ie $190k + $170k + $30k new loan), and so your home’s appraised value has to be at least $488k to avoid having to pay PMI ($390k � $488k x 100% = 80%).
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The bottom line is that you must work out the numbers (eg the interest charges, closing costs, monthly repayment amount, total loan interest over the loan period, APR, etc) under each possible option to determine the best choice before you make your decision.
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