One of the pieces of advice you hear over and over in the financial industry is, to not borrow money against your home for basically any reason.
There are some people who suggest that it’s OK to take out a home equity line of credit (or HELOC) so you can invest the funds, or make improvements on your home. But to pay off consumer debt? That’s a no-no. I always thought this was a wise piece of advice, but recently decided not follow it.
My husband and I bought our first home two years ago, when the market was incredibly low, for $172,000 at a 3.5% interest rate. A smart financial move on our part.
We also financed a brand new KIA SUV for about $31,000 at a 1.99% interest rate, after trading a car we were already upside down on. Perhaps not a smart financial move. Fast forward two years, and we’re looking into refinancing our home because we wanted to drop the $2,200 additional annual private mortgage insurance (or PMI) cost.
Our broker friend encouraged us to refinance our 30-year fixed mortgage into a 15-year fixed loan, if we could afford it. After some number crunching, we discovered that we could refinance our home and be able to pay off the KIA SUV in the process. In addition, we would be able to save a little extra money each month. Also, our home was appraised for $280,000, which was quite a bit more than what we paid for it.
Will Our Refinance Save Us Money?
After coming to this realization, we decided to go for it, and refinance our mortgage loan. Of course, when you cut your loan repayment time in half (from a 30-year fixed loan to a 15-year fixed one), you end up paying higher monthly payments. However, since rolled our car loan into the mix, we no longer had that hefty payment each month.
Here’s how the monthly numbers changed:
| Loan Type | Before Refinance | After Refinance |
| Mortgage Payment | $1438 | $1788 |
| Car Payment | $500 | $0 |
| Total | $1938 | $1788 |
Not only are we paying $150 less each month after our refinance, but we’re also on track to pay off our home about 12-13 years sooner –the new mortgage price reflects the added money taken out to pay off the home quicker. We are also saving $2,200 a year because we eliminated the PMI cost, so that’s a nice added benefit.
Won’t the Car Cost More in the End?
One thought I had while increasing our mortgage to pay off the SUV, was that we’ll end up taking a longer time to pay for the car, and subsequently end up paying more for it. This is because our car loan got hitched to a longer loan with a larger interest rate.
However, I knew we wouldn’t have been able to afford to refinance into a 15-year loan with the additional $500 auto loan payment due each month. For us, the trade-off was worth it. We may end up paying more for the car, but ultimately we will pay less for the mortgage.
Should You Refinance Your Home to Pay Off Debt?
I think in our case, it was a smart move. We were extremely lucky to have gotten our home at such a great price, that it’s now worth over $100,000 more than what we paid for it. Even if the market shifts down again, I’m still confident that we could sell our home for more than our mortgage refinance, which is always a relief.
Also, the move to pay off the car was orchestrated to pay off debt for good and to move our life to debt-free living. We aren’t going to add another car loan to our load, and hopefully never will for the rest of our lives. With the extra $150 savings, we have been attacking the rest of our debt (about $5K worth). And within a few months, the only debt we’ll have (and hope to ever have) is our mortgage.
I definitely think borrowing against your home can be wise if used to pay off debt and accelerate a debt-free lifestyle. Borrowing against your mortgage to pay for luxury items or vacations, however, is not a good idea. You don’t want to use the equity in your home to pay for consumables, or things that don’t bring value to the table.
Do you think it was smart for us to refinance our mortgage to pay off debt? Would you have done the same, or did I make a dumb financial move?
{ read the comments below or add one }
Well, I like the Dave Ramsey plan of doing the baby steps to pay off all small debt, building up your emergency savings account, following his steps up to paying off the mortgage early. I’m of the mindset that rolling your car loan into your home is not a good idea. Rolling ANY consumer debt into your mortgage just stretches all those steaks and clothes and movies and cars into a verrrrry loooong payoff! Not good. But what’s done is done for you. So what good are our opinions? We have followed Dave’s steps and are debt-free except for our home which we just refinanced to a 15-year loan and are on schedule to pay off in way early in 5 years in 2020. Good luck with your own early payoff. Put those extra funds you were mentioning that are now freed up straight towards your mortgage. Surprising how much faster than 15 years you can pay it off when you pay attention. Oh, and be sure you’re contributing 15% of your income to your retirement fund before you do anything else! Best to you.
I agree with Steve. 1.99% on car loan was a good deal. When I bought the house, my broker recommended I put in only 5% – increasing the down payment wouldn’t have changed the rate any further. Also, he suggested invest the difference (15 vs 30 yrs) which I did with Betterment and Vangaurd. So I will keep doing it and in 15 yrs, I will have saved enough to just pay off the remaining balance or keep doing what I was doing. My mortgage payment doesn’t change (prop tax+ins will increase). Having liquidity is more important than paid off home – for me.
Now since buying the home, it has appreciated quite nicely. We would like to do some upgrades and am wondering if I use my cash or access home equity via HELOC. Any suggestions on HELOC? credit union vs big banks, 5, 10, 15 yrs? I am consulting with my realtor reg what upgrades to what extent to do so that maximum value could be recouped. Like he said don’t change the kitchen layout but putting in granite might be worth, etc.
When you borrow, you are going to come out ahead if you find a loan with the best terms, be it interest rate, closing costs, prepayment penalties or servicing fees. Don’t get too hung up with whether it’s from a credit union or a big bank. Just shop around.
Use your cash. Why take out a loan? If you have the cash use the cash. If you take out a loan you are kidding yourself. You’ve already paid for it so just pay for it upfront already. Why would you want payments over years and years? Use your cash.
Interesting perspective! We’ve been considering doing this to pay off our car and student loans, but you’ve made me reconsider! Thanks!
No way should they have stayed with a 30 year mortgage – I don’t care what kind of “great” interest rate they had. They were absolutely right to go with a 15 year mortgage ’cause all the good intentions of paying that 30 year mortgage off in 15 years rarely works. Life happens and when you’re not “forced” to put that $ on your mortgage it is way too easy to find things that you “need” to put that money towards. I say “good for them”.
I appreciate your comment. I agree that staying with a 30 year loan would never have motivated us to pay off the loan quicker. As you said, life just happens, and it is so easy to spend that “extra” you said you were going to save on something else. The good news is that since I have signed up for extra to be taken out, we will actually pay off the loan in 12.5 years without even thinking too much about it. Woo-hoo!
Then why couldn’t you have signed up with the 30 year loan to have extra taken out? But to say you wouldn’t have the discipline to pay more on your own to me is a cop out. How about the well known rule of “pay yourself first?” And what happens when “life gets in the way”, and”life just happens”, and you don’t have the money to pay the now higher 15 year mortgage? It happens all the time to all the best intentioned plans.
Aren’t you also considering saving for the next car to buy it in cash instead of paying extra on your home loan? If you can’t afford the car and mortgage payments both, then what are you going to do when it bites the dust? Are you assuming the SUV will last until the house is paid off?
Another excuse. If you are serious about getting ahead, which they seem to be, it’s best to allow for the unexpected problems of the future and give yourself the flexibility. Pay yourself first is the way to do it so that when “life happens”. But when life happens and they need to pay less, with the 30 year mortgage, they have more flexibility.
There are good arguments for both points of view Steve. You are, of course, right that a 30 year mortgage gives someone more flexibility in exchange for a higher interest rate.
But remember that personal finance is just as much about psychology than it is about math. The higher required monthly payment on a 15 year loan does help take away all kinds of excuses to spend more. There’s no right or wrong here.
Do whatever works for your situation and we can all laugh about it in 20 years when we are debt free!
Well said!
No. I don’t think it was a smart move. You should have refinanced to get rid of the PMI but you should have stayed with a 30 year mortgage. Then you would have the ability to add extra payments to shorten the loan, but the flexibility to pay less should times get tough. Which history shows could happen. Only paying 1.99% for the car is a great deal so you should have kept it, rather than end up paying so much more for the car. With a 30 year loan, you could have your cake and eat it too. Then when your car was paid off, you would have really been ahead. But this is how you learn.
Definitely love your feedback. We are still paying less than it would cost to rent for our mortgage and will be mortgage-free before 40, so I guess that is always a positive.
Being mortgage free before 40 is an amazing goal to achieve. Let’s break out the champagne when you make that last payment Ashley!
What is the rate on your new mortgage? I don’t think I have enough information to tell you if I think this was a smart choice.
I will say that I applaud you for getting on track to get rid of your credit card debts.
Opps- forgot that part. It’s the same rate, maybe slightly lower. Pregnancy brain 😉