Refi or Personal Loan to Vanquish Credit Card Debt?

From online shopping to checking into hotels, hailing rides, and paying bills, credit cards are practically indispensable nowadays. Is it possible to live without one? Probably, but we'd rather not try, especially since we can carry around a virtual card in our phone's digital wallet or store it at an online retail account, like Amazon. Today, whipping out your credit card to buy something is easier than, well, whipping out an actual card.

And wow, do we pay for the convenience! The interest rates of some credit cards would make a loan shark blush. By and large, we pay a higher rate for this debt than for any other in our life, whether it's a mortgage, a student loan, or an auto loan.

The average credit card interest rate right now is a sobering 20.28%, with store credit cards the highest of all. You might suspect that such high rates are due to a temporary spike during the coronavirus pandemic, but no. Rates are actually down a percent from just before nationwide lockdown measures. Credit card rates are high because this kind of debt is always really, really expensive.

Two popular strategies for escaping credit card debt are to refinance a mortgage or to take out a personal loan. Here we discuss the pros and cons of each approach.

Mortgage Refinance to Pay Off Credit Cards

Securing a much lower payment through a mortgage refinance could free up hundreds of dollars to pay down credit card debt. This approach takes financial discipline because every month there will be the temptation to spend the money elsewhere and to keep charging more on the cards. You must hold fast to the goal of paying those credit cards down, down, down, until they're paid off.

The next thing to consider about a mortgage refinance are the closing costs, the mostly unavoidable fees to get the loan off the ground. All mortgages have closing costs, and they're generally 2%-6% of the loan amount. The national average is about $5,800 with taxes.

Although a lower payment will start as soon as the loan closes, real savings doesn't kick in for many months. In the meantime, your monthly savings is offsetting the closing costs. Once you've saved enough money on payments to make up for what you paid to close, you've reached the breakeven point of the refi. Now you enjoy pure savings.

The Cash-Out Option

Since a mortgage refinance is essentially taking out a new loan to pay off an old loan, you have the opportunity to borrow a higher amount than you owe on the old loan and take the difference as cash. With this, you can immediately pay off those credit cards and start using them strictly as temporary floating cash, always paying off each balance when the bill comes.

The downside of paying off credit cards with money from a cash-out refinance is you are replacing unsecured debt with secured debt. The whole new loan amount—the old mortgage balance plus the cash on top—is now tied to your home. When you can't make payments on a mortgage, you could lose the home, whereas if you can't make payments on a credit card, it’s not like they come to your house and take away the socks, groceries, and video games you charged on the card.

Securing a much lower payment through a mortgage refinance could free up hundreds of dollars to pay down credit card debt.

If the numbers are in your favor, however, you can take cash out during a refinance and keep your payment the same, keeping the risk of defaulting low. With interest rates as low as they are today, it's quite possible to take out a new loan that covers the cost of the old loan as well as an extra amount of cash without raising your payment. Since your payment isn't higher, you're at no greater risk of defaulting on the mortgage than you were before the cash-out. You've already proven you can make that payment comfortably.

Personal Loan to Pay Off Credit Cards

Compared to a mortgage, a personal loan is much simpler in three major ways. First, the loan isn't secured by a home or any other property. Second, you borrow on the strength of your financial reputation, not the value of your collateral. Lastly, the terms (time periods) are much shorter than a mortgage, usually three to five years.

The average interest rate on personal loans right now is about 10.5% (three-year), which is about half the average interest rate on credit card debt. A personal loan is an attractive strategy for escaping credit card debt because the interest rate can be so significantly lower.

The next two, three, four, or five years are going to pass anyway, and you're going to be paying down debt every month anyway, so the question is: What do you want to make payments on? Multiple high-interest credit cards or a single lower-interest personal loan?

If your rate is much lower than average on your credit cards, you're probably considered a good borrower and have a high credit score, which also means you could qualify for a personal loan with a rate much lower than average.

While personal loans don't have closing costs per se, some lenders charge an origination fee. Both are ways of making the borrower pay to get the loan off the ground. When shopping for a personal loan, compare such features as origination fees, late fees, and prepayment penalties in addition, of course, to interest rates.

Look at the interest rate you're paying on credit cards to judge whether a personal loan is right for you. For some, the interest rate on the card is roughly the same as what they could get with a personal loan, while for others, a personal loan would be well worth looking into.

And Don't Blow It (You Got This!)

The promise of debt consolidation is realized when you pay off bad debt, like credit card balances, with better debt, like a personal loan at a lower interest rate or cash from a mortgage refinance. The key is to pay off those credit card accounts, then never charge more on the cards than you can pay off the same month. You won't pay a single dollar in interest this way. That's the promise of debt consolidation.

Whether you pay off the cards with steady monthly savings from a mortgage refinance, all at once with a cash-out refi, or by taking out a personal loan, you only win if you keep the card balances zero. Use a card purely for convenience and to earn airline miles or other perks, but pay the balance entirely when it comes, every month. If you start racking up debt on the cards again, you blew it.