Thirty-year fixed mortgage rates have dropped from above 6 percent to below 4 percent. This has touched off an unprecedented refinancing opportunity for homeowners. However, unless they learn to take a broader view of refinancing, those homeowners may be missing out on the biggest money-saving opportunities.
By now, home prices have recovered to levels higher than at any time other than the peak years of the housing bubble. Between that and the principal payments homeowners have made over time, most should be finding that they are building up a healthy cushion of equity in their homes.
The combination of that equity and some of the lowest mortgage rates in history may give many homeowners the option to refinance. However, to make maximum use of that equity and those low refinance rates, homeowners should consider refinancing other debts as well, since these are typically at higher interest rates. Using cash-out refinancing can enable you to take this broader view of refinancing, but there are some catches.
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The following walks through a full range of possible debts, and discusses the issues involved in incorporating each into a comprehensive refinance approach.
- Credit card debt. Credit cards typically charge interest rates that are more than three times as high as mortgage rates, so using cash-out refinancing to pay off credit card debt represents an opportunity to save a lot. The catch is that you would be trading unsecured credit card debt for debt secured by your home, so you need to make sure your spending habits are under control before you do this.
- Student loan debt. The government backs most student loan debt to keep interest rates reasonable, but you may still be able to save money by refinancing it with mortgage debt. However, you should only do this if you are confident in your job security, because student loan debt may have more flexible repayment terms in the face of financial hardship than mortgages do.
- Car loans. Auto loans generally carry higher interest rates than mortgage loans, so this might be a refinancing opportunity. However, the gap between the two types of rates has narrowed in recent years, which may mean it is not worth folding auto debt into a mortgage loan with a longer repayment period.
- Second mortgage. If you have a second mortgage, you should consider consolidating it into any refinancing analysis. Second mortgages generally carry higher interest rates than primary mortgages, though this depends heavily on when the loans were originated.
- First mortgage. While this whole discussion might seem to center on refinancing your primary mortgage, you should not start reviewing mortgage quotes until you have taken into account all of the above possibilities. That way you can choose the mortgage structure that best meets your broader refinancing needs.
Keep in mind that debt consolidation should not be the ultimate goal of your financial management, but simply a means to an end. The real goal is to put your finances on a path to sustainable success, where you are building wealth rather than building debt. If you can put a budget in place that will get you to that goal, then making maximum use of low mortgage rates through a comprehensive approach to refinancing can help you get there more efficiently.
Author: Richard Barrington
Richard Barrington, CFA, is a 20-year veteran of the financial industry, including having served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc.