Are you in over your head in credit card debt? Do you have equity in your home? If you have an FHA loan, you may consider an FHA cash-out refinance to get yourself out of that debt. While it might be a great strategy, it is important that you take certain precautions before you wrap your credit card debt into your home.
Credit Card Debt is Unsecured Debt
The first word of caution is that your credit card debt is unsecured debt. The credit card companies can’t take anything away from you if you don’t pay your bill. Yes, they can slap a judgment on you, but this takes a lot of time.
Once you transfer that credit card debt to your mortgage, though, it becomes secured debt. It is now secured by your home. If you don’t make your mortgage payments, the mortgage company could take your home. That’s a big pill to swallow when you think about it. You must make sure that you can afford the new payment carefully before you consider this option.
You’ll Pay Mortgage Insurance
All FHA loans have mortgage insurance requirements. You pay this insurance for the life of the loan too. It’s not like a conventional loan where you can cancel the PMI once you owe less than 80% of the home’s value. No matter what you owe, you pay mortgage insurance.
This will add to your monthly cost. The insurance is 0.85% of your average outstanding balance for the year. This could mean a large amount of extra money you have to pay because you wrapped your credit card debt into your loan. Before you do it, compare the payments; is the new mortgage payment any lower than the combined minimum payments of your credit cards?
You’ll Make Payments for 30 Years
If you opt for the 30-year fixed rate loan, you just spread your credit card debt out over 30 years. Chances are that it would not have taken you that long to pay off the credit card debt before you wrapped it into your mortgage, so this is something to consider.
It’s not necessarily that the debt is spread out over 30 years, but rather that you will pay interest on those payments for the next 30 years. This means the money now costs you more. If you were able to score a low interest rate on your FHA refinance, it may be worth it though, especially if you were paying interest rates upwards of 20% – 30% on your credit cards.
Can You Stay Out of Debt?
Perhaps the largest risk is keeping yourself out of debt. Are you the type of person that will rack up your credit cards again once they are paid off and in your mortgage? This will defeat the purpose of refinancing your debt into your mortgage.
You want to keep the credit cards open because closing them could damage your credit score. The credit bureaus measure the average age of your credit. If you close old credit card accounts, it could make your credit age much younger, which could decrease your credit score.
But if keeping them open will be too tempting for you to use them to spend money, you may want to take the chance and close the accounts. If you can handle it, though, keep them open and just lock them up in a safe or give them to someone that will hide them for you. This way you have the available credit, your credit utilization rate will be low and your credit age will remain high.
Should you wrap your credit card debt into an FHA cash-out loan? It really depends on the situation. You have to work out the numbers. Will you save money? Can you handle not using your credit cards any longer? Are the closing costs worth it? These are all questions you must ask yourself in order to ensure that you make the right decision.