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05/11/09: Rolling All Debt Into A New Mortgage

Housing Counsel

By Benny L. Kass

Q: With the mortgage loan rates at record lows, I’m thinking of refinancing my 30-year fixed rate loan. The lender is recommending that I roll into the refinance amount the balances I owe on my car and two credit cards. The advantages would be that they’d be “paid off” (would no longer have those monthly payments to worry about), the interest rate on the amounts would be lower than I’m currently paying on any of them, and the interest paid would be tax-deductible.

But I think I’m seeing a big disadvantage, too. The total of the amounts on my 5-year car loan (on which I still have 3 years to pay) and revolving loans would now be amortized over 30 years! Does it make sense to do that? How can I figure out if it’s a smart move or not? Do you have a recommendation?

A: You have to review a number of factors before you can make up your mind. Let’s review the pros and cons of consolidating your various debts into a larger mortgage.

Pros: as you suggested, the rate on your refinance loan will be lower than you currently are paying. Furthermore, only mortgage interest is deductible; the interest you pay on your car loan and on your credit card debt is not. However, you should talk with your tax advisor to confirm that you will be able to deduct all of the new mortgage interest. Under our tax laws, you are only able to deduct interest on the amount of the old loan at the time of the refinance (called “acquisition indebtedness”) plus interest on an additional hundred thousand dollars. While I doubt that the combined debts you are considering rolling into the new loan will be over $100,000, it is important to know the facts before you enter into that new loan.

Cons: you will pay off your car loan in three years, but if you go the route suggested by your lender you will be obligated to make monthly payments for 30 years. You can, of course, shorten the term by making additional monthly payments.

Another possible negative is that by increasing your loan, you will have less equity in your home. This might impact on the cost of your mortgage, since it could push you into a higher loan to value (LTV) category. For example, if your house is appraised at $400,000, you get a better rate of interest if the LTV is 80 percent – or $320,000. If you will now have to borrow more than this amount, your LTV becomes higher which will raise a big red flag with your lender. Additionally, you want to make sure that by adding your other debt to the loan, you inadvertently fall into the jumbo loan category. Such a jumbo loan carries a higher interest rate. In either situation, this change would increase your cost – i.e. your monthly payment -substantially, which would more than offset the gains from consolidation.

I ran your question by Jack Guttentag, the Mortgage Professor, and he presented yet another negative. According to the Professor, “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.”

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

These are some of the questions you should be asking yourself while considering whether to consolidate your debt into that new mortgage. I am not opposed to the concept, but perhaps a better option would be to refinance your existing loan now that interest rates are so low, and use the saving to pay off (or at least pay down) your existing car loan and your credit card debt. This could be a win-win for you, since you will not increase your loan amount but at the same time will reduce or completely pay off those unsecured debts.